Column: For U.S. retirees, rising interest rates a
double-edged sword
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[January 04, 2018]
By Mark Miller
CHICAGO (Reuters) - U.S. interest rates
finally are on the rise after a decade stuck near zero - and that should
be good news for retirees who need yield on safe investments like
certificates of deposit and money market accounts.
But higher rates will not be welcome news for all retirees.
Americans are more likely than ever before to enter retirement carrying
debt, which leaves them vulnerable to rising interest rates. A recent
study coauthored by Olivia S. Mitchell, executive director of the
Pension Research Council at the Wharton School of the University of
Pennsylvania, finds that growing debt obligations of older households
leave them vulnerable to rising rates - and that an increasing share of
their incomes will need to go to servicing debt.
No doubt, the yields available on savings are showing signs of life
after a decade when ultra-low interest rates were a key tool used to
stimulate the economy following the Great Recession.
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The Federal Reserve raised short-term interest rates three times last
year - most recently in December - and most economists expect several
more rate hikes in 2018. Consumer yields on certificates of deposit and
money market funds will rise, although not as quickly as loan rates.
Still, rate shoppers interested in a one-year CD this week can find
deals ranging from 1.65 percent to 1.80 percent, according to
Bankrate.com. Three-year deals can be had around 2 percent.
Mitchell’s study is based on data from the University of Michigan Health
and Retirement Study. (http://hrsonline.isr.umich.edu/) She found that
the rise of home prices over the past two decades, and the growth of
easier mortgage products are key factors driving increasing debt burdens
among older households.
“Real estate has played a very important role in this,” she said. “More
expensive houses are a very large factor in the rise of debt. We’re also
seeing people with larger mortgages on the larger houses - the old rules
of putting down a certain down payment have changed.
Conventional wisdom holds that retirees should shed as much debt as
possible - of any kind. But all debt is not equal, and some debt is
relatively safe and can improve your liquidity - for example, a low-rate
fixed mortgage that represents a relatively small portion of a home’s
value and that could be paid off if necessary.
But in the emerging rising-rate environment, a key question is how much
debt being carried by older households carries variable rates, leaving
borrowers exposed to substantial jumps in rates?
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FINANCIAL FRAGILITY
Mitchell’s research suggests that 20 percent of all U.S. consumer debt
is variable. The most worrisome figure: 40 percent of households aged 62
to 66 reported carrying credit card debt in 2015. That was down slightly
from 2012, when 43 percent of this age group carried credit card debt,
but still quite high. Carrying balances on cards is especially
dangerous; as the balance grows, interest rates get higher, and credit
ultimately is cut off.
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A pair of elderly couples view the ocean and waves along the beach
in La Jolla, California March 8, 2012. REUTERS/Mike Blake
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One factor driving these numbers is what Mitchell and her colleagues call
“financial fragility” - the inability to respond to an unexpected financial
shock. For example, 36 percent of households aged 56-61 said in 2015 that they
could not come up with $2,000 within a month’s time to meet an emergency
expense; 23 percent of households 62-66 said the same thing.
Roughly 20 percent of households aged 56 to 61 have unpaid medical bills,
reflecting the rising cost of healthcare. “When you’re considering whether
you’re ready to retire or not, a key thing is to understand is that medical
costs are going to be high,” Mitchell said.
She also thinks the debt statistics point to the need for greater financial
literacy. Her previous research on this topic measures literacy by posing three
basic questions about the workings of compound interest rates, how interest
rates interact with inflation and how to avoid stock market risk. Only one-third
of test-takers are able to answer all three questions correctly.
But other factors are at work.
Social Security benefits have become less valuable over time as a result of
reforms enacted in 1983 and the growing share of benefits consumed by Medicare
premiums. Fewer households have access to defined benefit pensions, and many
households have not been able to accumulate savings - 47 percent told the
Employee Benefit Research Institute last year that their total household savings
and investments were less than $25,000.
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Retirement stresses are especially acute among older minority households. They
are far less likely to have access to workplace retirement saving accounts than
their white counterparts, and their rates of home ownership are far lower
(http://reut.rs/2lPezaM).
Taken together, the data underscores the need for a holistic approach to
financial planning as retirement draws near - one that balances spending needs
with short- and long-term goals. If you are approaching retirement age carrying
dangerous debt - a variable mortgage or credit card with a high balance -
reorder your financial plan to focus on minimizing or eliminating it. Smart
strategies include favoring debt reduction over saving or downsizing your home.
Working longer also can play a big role. More years of earnings not only provide
income to pay down debt, but set the stage to maximize your retirement income
through delayed filing for Social Security benefits.
(The opinions expressed here are those of the author, a columnist for Reuters.)
(Editing by Matthew Lewis)
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