3 Ways Low Interest Rates Hurt Seniors

Beyond savings and CD rates, Fed policy is also changing fundamentals of key senior financial products.


The Federal Reserve Board has not formally relaxed its intention to keep interest rates low through the end of 2014. And there is little new to say about the way non-existent interest rates on savings accounts, certificates of deposit, and U.S. Treasury securities have hurt all savers, particularly risk-averse investors.

[See 10 Steps to Fine-Tune Your Retirement Plan.]

Retirees are, of course, the poster children for risk-adverse investments, and their nest eggs have been hammered by the Fed's policy. The Fed has said that low rates help the economic recovery. So it argues, in effect, that investors should enjoy the solid stock market returns and that savers should display a stiff upper lip.

Perhaps the Fed policy carries a price that we all must pay. But 15 of 19 large financial institutions just passed their latest financial stress test. Do they still need free money from the Fed to see them through? Corporations are already sitting on enormous piles of cash. Do low interest rates play a material role in their current thinking about raising funds to expand their businesses and hire more people?

Meanwhile, insurers and other providers of financial products have been twisting in the wind because of the Fed's policy. In ways that often aren't that visible to ordinary consumers, they have been forced to change their products and services. Older consumers and retirees have been particularly hurt by these changes.

[See Estate Plans Reeling from 'Volatility Fatigue']

Long-term care insurance. According to the American Association for Long-Term Care Insurance, rates on new policies are 6 to 17 percent higher than a year ago. The culprit? Low interest rates. "Insurance prices have increased as a result of the historic low interest rates and yields on fixed income investments," says association executive director Jesse Stone.

Many long-term care policies are purchased by people in their 50s and 60s. Typically, claims aren't made against these policies for 20 or more years. During that time, insurers invest premiums in safe investments whose yields are tied to prevailing interest rates. With rates so low today, insurers can't earn very much on their premium reserves and thus feel they must charge higher rates to new customers.

Annuities. For the same reason, insurers have been forced to reduce payment guarantees on their most conservative and safest annuity products: fixed rate annuities. These products are the ones that many financial experts often recommend for older investors. That's especially the case when an older person wants to convert a retirement investment nest egg into a guaranteed stream of lifetime income. With interest rates so low, that stream has become a trickle, and sales of fixed annuities have suffered.

[See 4 Ways New Annuity Rules Will Help Retirees.]

Pensions. While we're on a roll, let's add pensions to the list of retirement products that are being badly hurt by low interest rates. Beyond reducing potential payouts for retirees, pension plans may also wind up hurting taxpayers and their parents—private companies and state and local governments.

Pension plans use an assumed rate of future investment profits to determine how much money they must set aside today for their employees' future retirement needs. Even if low interest rates did not adversely affect future pension investments, which is arguable, they certainly reduce the level of lifetime payouts when a retiree's pension benefit is annuitized in his or her plan. This is a typical conversion that occurs in pension plans so that the plans can lock in future payout requirements.

If a pensioner is promised, say, $800 a month in pension benefits, however, the plan will have to set aside more money to generate an $800 monthly annuity payment when interest rates are so low. Yes, the reasoning is complex. But the impact isn't. Retirees get hurt, either through lower pension payments, higher pension-plan contributions, or both.