Retirees face income drop as term deposit rates fall, what to do – Nadine Higgins

THREE KEY FACTS

• Reserve Bank data shows over $370 billion in mortgage debt, with interest rate drops saving $3.7 billion per percentage point.
• Term deposit rates have fallen from 6% to 4.3%
• This has the effect of reducing income for retirees relying on savings.

When the official cash rate falls, the impact on those who have a mortgage gets all the attention – and that’s fair, to a point.

Reserve Bank (RBNZ) data shows New Zealanders have more than $370 billion in mortgage debt, so the impact of interest rate changes is significant. Based on that number, a one-percentage-point interest-rate drop equates to a cool $3.7b not being spent on interest. Given rates have dropped more like 2 percentage points for many people, the change in the interest burden is not small beer.

But there is also an inverse impact on people who have savings or term deposits – it’s just often overlooked.

Craigs Investment Partners investment director Mark Lister says “This time last year, the six-month term deposit rate was at a 15-year high of 6%”.

“Today, those same term deposit rates are at about 4.3%, which represents a fall in income of more than 25%, and there are more declines to come”.

Ouch. Plus, those who opt to put money on term deposit are often doing so to provide a reliable, low-risk supplement to an otherwise fixed income – that is, retirees.

Superannuation payments are inflation adjusted, which is helpful when the cost of everything continues to rise, but the pension isn’t designed to cover everything in retirement (and the research confirms it doesn’t).

That means a drop in investment income can have an outsized impact on the cash flow of retirees.

So, if that’s you, what should you do?

Keep it in perspective

While it’s not fun to see interest rates fall when you know it will directly impact your back pocket, it’s worth putting the numbers in context.

In June 2023, the average 18-month term deposit rate was 5.5% – but inflation was running red hot at 7.3%. So, even before you subtracted tax, the “real” return – ie after inflation – was firmly negative. There is false comfort in a better interest rate on your term deposit if inflation is eroding what that money will buy you at a faster clip – it’s the real return that really matters.

So, while term deposits rates are down, inflation is now back within the Reserve Bank’s target band, which is a good thing.

Consider your short-, medium- and long-term needs

There is a tendency for those stepping away from the workforce and retiring to think they need to sell all their investments and put it somewhere ‘safe’, believing they can no longer afford to take any risk.

While it’s true your risk profile should become more conservative the closer you get to needing the money, if you’re stretching your nest egg out over 20 or 25 years, some of that money isn’t required in the short term. While you need to favour safety for the funds you’ll need imminently, that longer timeframe means you could – and arguably should – be investing some of your funds with an eye on growth. How much you should invest in “growth” options requires some budgeting, lifetime cashflow planning and, I’d suggest, some good financial advice.

Consider the alternatives

Term deposits are not the only option that can form part of a conservative investor’s asset mix.

Bonds don’t get as much press as shares but are an important part of many lower-risk managed funds. Many can offer a better return than term deposits, but they are less volatile than shares. Unlike shares, where you own part of a company, with bonds, you are loaning a corporation or Government entity money at an agreed interest rate for a fixed term. That makes them a lot like term deposits – but one of the key differences is the price of the bond can go up and down over time.

There are also different ways to buy bonds – directly, via an exchange-traded fund, or managed fund, with different benefits (including taxation) to each option. Not all bonds are created equal, however. Says Lister, “Corporate bonds typically offer higher yields than government bonds, as compensation for that higher credit risk (which means their ability to repay you). The structure of a fixed income security can also change the risk profile”.

Suffice to say that, while bonds do provide an alternative to term deposits, there’s more to understand – so it’s important to seek advice to work out what’s best for your situation.

What about other options?

When you’re looking around for the best rate, you’ll find other providers out there touting a better return – but please don’t fall into the trap of ignoring the higher risks that accompany some of them.

An enduring memory of my first years as a finance reporter was interviewing devastated Kiwis who had invested in finance company debentures for a slightly better return, only to rue that decision as dozens of them went bust, one after another.

That said, there is a “depositor guarantee scheme” coming into effect on July 1 that will change things. It will protect funds of up to $100,000 deposited with eligible “deposit takers”, which the RBNZ says means “New Zealand registered or licensed bank, building society, credit union or finance company that takes retail deposits”. But be aware it’s on you to ensure where you’re putting your money is covered by the scheme, and if they do fail it could well take some time to recoup your money.