The Impact of Fed-Driven Interest Rates on Retirement Plans: Exploring Your Options

Next week's The Federal Reserve meeting has everyone on pins and needles. Will they? Won't they? What amount will the rate cut be? The Fed’s interest rate policies don’t just make headlines—they also have a real and measurable impact on retirement plans. As a retirement plan sponsor, understanding these impacts can help you better guide your employees through periods of rate volatility.

So how do rising and falling interest rates affect retirement plans, and more importantly, what options should you offer participants to protect their savings? Let’s take a look.

Rising Interest Rates: The Impact on Bonds

Bonds are a staple in many retirement plan investment menus, especially for participants with more conservative risk profiles or those nearing retirement. However, when interest rates rise, the value of existing bonds tends to fall and vice versa. Bonds and rates have an inverse relationship. This can be a concern for participants heavily invested in bond funds, as their current holdings may lose value.

On the flip side, new bonds issued during a higher-rate environment offer better returns. Participants purchasing new fixed-income securities can benefit from higher yields in the long run, but those holding older bonds may face short-term losses.

To help participants better navigate an interest rate environment in flux, consider offering bond options with specific characteristics designed to mitigate the effects of rate changes. Some key strategies include:

Duration-driven Bond Funds: Short-duration bonds tend to be less sensitive to interest rate hikes than their long-duration counterparts. These funds focus on bonds with shorter maturities, which means their prices are less likely to drop significantly when rates rise. This makes them an attractive option for participants who want to maintain some bond exposure but are concerned about rising rates impacting the value of their investments. Offering short-duration bond funds in your plan can give participants a safer harbor during times of increasing rates, without abandoning fixed income altogether.

While short-duration bonds provide protection in a rising rate environment, long-duration bonds excel in periods of declining interest rates. As rates fall, the value of long-duration bonds tends to rise more dramatically, offering participants potentially higher returns. These bonds can be an important tool for those with a longer investment horizon or for participants who believe rates may decrease in the future.

Treasury Inflation-Protected Securities (TIPS): TIPS are government-issued bonds that offer protection against inflation, a common concern during periods of economic volatility. Unlike traditional bonds, TIPS adjust their principal value based on inflation, meaning their payouts grow with rising inflation rates. As the Federal Reserve grapples with inflationary pressures, offering TIPS within your plan provides participants with an option that preserves purchasing power even in uncertain economic times. TIPS can be especially appealing to employees nearing retirement who want both stability and inflation protection in their portfolios.

While TIPS can be a great hedge against inflation, they may not always shine in low- or non-inflationary environments. If inflation remains low, the inflation adjustments on TIPS will be minimal, meaning they may underperform compared to other types of bonds. Additionally, their yields tend to be lower than those of comparable nominal bonds, so in periods where inflation is subdued, participants could miss out on the higher returns offered by other fixed-income securities.

Age-Based, Risk-Based, or Managed Accounts: Offering age-based, risk-based, or managed accounts solutions within your plan can be a great way to help participants better manage their risk. Managed portfolios, with an intentionally set equity to fixed income allocation can help tailor investment strategies to an individual’s goals, time horizon, and risk tolerance. This can be especially helpful in an environment where interest rate changes cause uncertainty, as professional management adjusts the asset allocation as needed, ensuring participants are consistently aligned with their retirement objectives.

By expanding the offerings within your retirement plan—such as including duration-driven bond funds, TIPS or providing a managed portfolio solution—you provide participants with greater flexibility to manage their portfolios in a fluctuating interest rate environment. Offering a mix of fixed-income products alongside equities and other asset classes can help employees strike the right balance between risk and reward, regardless of whether rates are rising or falling.

While the effects of rising or falling interest rates may seem distant to some participants, their impacts on long-term retirement savings can be significant. Without a diversified bond strategy, participants may experience unwanted volatility in their accounts, particularly if their fixed-income assets are overly concentrated in long-duration bonds or other rate-sensitive securities.

To minimize these risks, plan sponsors should consider working with a Retirement Plan Advisor to review and expand the plan’s investment menu. An advisor can provide valuable insights on market trends and help you identify the best fixed-income options for participants based on their risk tolerance and retirement timelines. They can also assist in helping to educate and communicate when and where different investment options would be beneficial to different employees on their retirement savings journeys.If you’re interested in exploring how some of these strategies can elevate the options available in your businesses’ retirement plan lineup - we're here to help! Email us today, Christina.Tunison@lpl.com.

This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.

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