What Do Higher Interest Rates Mean for Your Retirement?
After several years of steady or falling borrowing costs, interest rates are moving up again. In September, the Federal Reserve raised its benchmark rate by a quarter point to a range of 3.75% to 4%, its first increase since 2023, and the 10-year Treasury yield passed 5.35% in early October, its highest level since 2002. At its October 28 meeting, the Fed left that range unchanged, although two of the 12 voting members preferred another quarter-point increase. For pre-retirees and retirees, higher rates change what savings earn and what a new mortgage costs. They can also move the value of a pension lump sum by tens of thousands of dollars.
Who benefits when interest rates rise?
Savers are the clearest winners. High-yield savings accounts, money market funds, CDs, and short-term Treasuries now pay far more than they did a few years ago. On $200,000 held in cash, the difference between earning 1% and 4% is $6,000 a year. New bonds also lock in today's higher yields for their full term, which makes it easier to fund several years of planned spending with fixed income.
Who comes out behind?
Borrowers feel the other side. The average 30-year fixed mortgage rate was 7.32% as of October 22, up from 6.19% a year earlier. On a $400,000 loan, a 7% rate means a monthly payment of about $2,660, roughly $975 more than at 3%. That difference matters for anyone buying a smaller home or a second home with financing.
Existing bondholders also see their statements dip, because bonds issued at lower rates lose market value when new bonds pay more. A fund with a seven-year average duration could lose roughly 7% if rates rise one percentage point. Bonds held to maturity still repay their full face value, barring default. That is one reason Oasis funds near-term spending with a bucket approach that matches bond maturities to the years the money will be needed.
How do higher rates affect a pension lump sum?
Pension lump sums are calculated using interest rates published by the IRS, and higher rates shrink them. In one Milliman example, adding one percentage point to those rates cut an estimated lump sum by about 21%, from $116,800 to $92,600, with larger drops for younger participants. Many plans lock in their rates for a full year, so this year's increases may not show up in lump sum offers until 2027. Anyone with a lump sum option should find out when their plan updates its rates before choosing a retirement date.
Do annuities pay more when rates are higher?
Generally, yes. In the same Milliman analysis, a 65-year-old converting a $100,000 pension balance into lifetime payments would have received about $530 a month at late-2021 rates. A year later, after rates rose, the same balance would have paid about $690 a month. Annuities carry trade-offs in flexibility and cost, but higher rates make the pricing more favorable than it was a few years ago.
Are taxable bonds or municipal bonds a better fit right now?
Municipal bonds, issued by state and local governments, pay interest that is generally exempt from federal income tax. Comparing them with taxable bonds means looking at the taxable-equivalent yield, which is the rate a taxable bond would need to pay to leave the same amount after federal taxes. On October 1, a 10-year AAA municipal bond yielded about 4.09%, compared with 5.32% for a 10-year Treasury. In the 32% federal bracket, that muni is worth about 6.0% before tax, well above the Treasury. The edge shrinks to about 5.4% in the 24% bracket and disappears in the 22% bracket.
State taxes matter too. Treasury interest is exempt from state income tax, and most states tax interest on other states' munis, which makes this a bigger factor for clients in Kentucky, Georgia, or Pennsylvania than in Tennessee or Florida. Retirees should also know that muni interest still counts toward the income used to determine how much of a Social Security benefit is taxable. It also counts toward the income Medicare uses to set IRMAA surcharges. Munis generally belong in taxable accounts, since inside an IRA the tax exemption goes to waste.
Should retirees pay off a low-rate mortgage?
A retiree with a 3% mortgage is borrowing more cheaply than many safe investments now pay. Paying that loan off early effectively earns 3%, while Treasuries or CDs may earn more. Being debt-free still has value beyond the math, and that is a reasonable choice when it is made knowingly. For a newer mortgage at 7% or more, the answer flips, and extra payments may be one of the better guaranteed returns available.
What should retirees and pre-retirees do now?
Rates can move quickly in either direction. The Fed meets again on December 8 and 9, and nobody can reliably predict where rates will be a year from now. Rather than trying to time them, it makes more sense to identify which decisions in a plan are sensitive to rates and when each one needs to be made. A pension election, a planned home purchase, or a large cash reserve in a low-yield account all deserve a second look right now.
Oasis advisors build these questions into each client's plan, from how near-term spending is funded to the timing of a pension or annuity decision. For anyone weighing one of these choices, an advisor can model the options side by side using today's rates.
This article is for educational purposes only and is not investment, tax, or legal advice. Rates and yields cited are as of the dates noted and will change. Examples are hypothetical and for illustration only.