Saving Grace: How Near-Retirees and Retirees Can Benefit From High Interest Rates
After a decade or more of pitifully low rates, savers can finally get a decent return on their deposits. Photo: Camille Tokerud/Getty Images
The rapid interest rate hikes over the past year have been punishing for borrowers, but arguably a blessing for debt-free retirees and near-retirees. Indeed, after a decade or more of pitifully low rates, savers can finally get a decent return on their deposits.
The Bank of Canada might hit the brakes on its series of interest rate hikes, with inflation cooling off and economies slowing down. But it’s clear that Canadians have entered a new interest rate environment — one that offers plenty of new opportunities.
Here’s how retirees and soon-to-be retirees can benefit from rising
High Interest Savings Accounts
Just a year ago you’d be hard pressed to find a high interest savings account that paid more than one per cent interest. Today, according to the comparison website highinterestsavings.ca, more than 10 financial institutions are offering three per cent or more on savings deposits. That’s good news for savers who aren’t afraid to leave the friendly confines of their big bank environment and park their savings at an alternative or online-only lender.
A couple of caveats: The Canadian Deposit Insurance Corporation (CDIC) only covers up to $100,000 deposited with its member institutions. Credit unions are protected by provincial governments, most of which guarantee savings should the financial institution go out of business.
Funds held at online institutions aren’t always accessible by debit card, and there are no branches to visit. Instead, link your online savings account with your main bank account, where transfers can take one to two business days.
Guaranteed Investment Certificates (GICs) got little to no respect over the past decade, as rates fell to historic lows. With interest rates at, or only slightly above, the rates offered in a high-interest savings account, it hardly seemed worth locking up your money in a guaranteed deposit. At press time, savers could find GIC rates at or above five per cent for one- to five-year terms at several banks and alternative lenders.
That makes GICs an appealing alternative to bonds for the fixed-income portion of your portfolio. A soon-to-be retiree could set up a five-year ladder — where they put an equal amount into GICs that mature in one, two, three, four and five years — and earn a decent (and guaranteed) rate of return.
Compare that to short-term bonds, with yields of around four per cent at press time, which would still fall in price if interest rates ticked up and don’t yet offer the same juicy interest rates as GICs today.
Again, be sure to respect the CDIC coverage limits of up to $100,000
Inflation-Indexed Pensions and Government Benefits
One of the few advantages of a high inflation and interest rate environment is that retirees collecting Canada Pension Plan (CPP) and Old Age Security (OAS) will see a noticeable increase in benefits because they are indexed to inflation.
CPP recipients received a 6.3 per cent increase in their retirement pension benefits in January, while those collecting OAS can expect a similar increase (although OAS is adjusted every three months, instead of once a year). Once you reach 75, you will get another 10 per cent increase in OAS benefits.
These adjustments are permanent, mind you, just like receiving a cost-of-living increase in salary during your working years. So, while inflation cools off, your newly elevated CPP and OAS payments will give your income a boost.
And, for those fortunate to have a defined benefit pension, many workplace plans offer partial or full inflation protected benefits.
An annuity is an insurance contract that takes a lump sum and turns it into a payment for life. Think of it as another guaranteed income stream, along the same lines as a non-indexed workplace pension benefit (inflation-protected annuities are rare and expensive).
Economists and financial planners like annuities because they provide guaranteed lifetime income without risking money in the stock market, but annuities are mostly misunderstood and underused by the public. One reason is that it’s hard to conceptualize making a large upfront payment in exchange for small guaranteed monthly payments. You may also die before receiving all your money back, unless you pay a premium for the option to transfer payments to your surviving spouse or partner after you die. The low-interest rate environment has also reduced annuity payouts, making them less attractive. But with interest rates rising and likely staying elevated for some time, annuities may be worth another look.
I checked RBC Insurance’s annuity calculator to get a sense of how much an annuity would pay out at different ages and initial amounts invested. I also looked at the rates for males and females, as they do vary.
A 65-year-old male who bought a $100,000 annuity on or after Dec. 15, 2022, could expect to receive a guaranteed annual payout of $7,008, at a juicy rate of seven per cent. He would get all his money back in a little more than 14 years, so if he lived past age 80, his total payout would far exceed his initial investment.
I checked these estimates in May 2022, and the payouts today are between six per cent and 22 per cent higher, depending on age, initial amount and gender.
Indeed, a 65-year-old female who bought a $100,000 annuity today would receive $6,627 a year, compared to $5,411 a year if she purchased the same annuity in May 2022. That’s a whopping 22.5 per cent increase in the annual payout.
Savers rejoice! The low-interest rate environment of the past decade has come to an end. For retirees and near-retirees, rising interest rates offer advantages that haven’t been seen in some time.
That means earning a decent rate of return on cash savings and guaranteed deposits. It means a bigger boost in index-protected pensions and government benefits. It means higher interest payments from bonds, and the potential for bond prices to appreciate if interest rates fall again. And, it makes annuities an attractive option to create more guaranteed lifetime income.
A version this article appeared in the Feb/Mar 2023 issue with the headline ‘Saving Grace’, p. 44.