Retirement: Preparing for economic shifts amid Federal Reserve rate changes

With the Federal Reserve set to begin decreasing interest rates, analysts are divided on what lies ahead for the US economy. While some fear the economy will experience a broad decline, or recession, others believe the central bank can effectively avert a slump and carry out a "soft landing."

The potential impact of the Federal Reserve's actions is not limited to the stock market or broader economic indicators. It also has significant implications for the housing market, consumer spending, and business investments. Lower interest rates could lead to more affordable mortgages, potentially boosting the housing market. However, if consumer confidence wanes due to recession fears, spending might decrease, affecting businesses across various sectors.

What happens next is especially important for persons who are in or nearing retirement. A recession or rapid market collapse could disrupt the quantity of their retirement nest pile, the intended retirement date, or both. Everyone nearing retirement should be asking themselves, "What's my Plan B?" According to Anne Lester, author of "Your Best Financial Life" and former head of retirement solutions at JPMorgan.

"Now is a great time to build some scenarios and start asking yourself that question, 'What would I do?'" Lester stated. "If you have a plan, you're much less likely to panic and do something unwise."

In addition to having a Plan B, individuals should consider diversifying their income sources. Exploring part-time work opportunities or freelance projects could provide additional financial security. This approach not only supplements income but also keeps retirees engaged and active, which can have positive mental health benefits.

According to David Blanchett, managing director and head of retirement research at PGIM DC Solutions, persons approaching retirement are far more prone to fear when a downturn occurs. "Being proactive now is especially viable for older Americans for whom retirement is all of a sudden becoming very real," Blanchett told reporters. Asking few questions can help you assess your present retirement strategy.

Is my portfolio allocated correctly?

For retirees and near-retirees, a market downturn might trigger what's known as sequence of returns risk, in which bad investment returns reduce the duration of retirement funds.

"If you are nearing the end of your career or just starting retirement and a recession hits, then you have much less time than you'd like for your portfolio to recover," said Emerson Sprick, associate director of the Bipartisan Policy Center's economic policy program. Moreover, it's crucial to evaluate the tax implications of your investment strategy. Understanding how different accounts—such as Roth IRAs, traditional IRAs, and 401(k)s—are taxed can help optimize withdrawals and minimize tax liabilities. Consulting with a tax advisor can provide tailored strategies to manage tax burdens effectively during retirement.

According to Lester, a market selloff can occur without causing the economy to enter recession. And the economy can enter a recession without significant stock market falls. As a result, it's a good idea to be prepared for the markets — and your retirement savings — to take an unexpected significant hit. The good news is that it is uncommon for markets to experience a significant correction — defined as a 10% or more decrease — and then continue to fall, according to Lester.

"It is very unlikely that we rerun 1929 again, where you have five or seven years of very bad returns in a row," Lester told the crowd. Another consideration is the potential impact of inflation on retirement savings. Even if markets stabilize, rising prices can erode purchasing power. Retirees should consider investments that offer inflation protection, such as Treasury Inflation-Protected Securities (TIPS) or real estate, to safeguard their financial future.

Certain general rules of thumb, such as subtracting your age from 120, are intended to assist you determine how much you should have invested in stocks. (For example, if you are 50 years old, you should invest 70% of your portfolio in equities. If you're 70, equities should account for only 50% of your investments. However, Blanchett emphasizes that everyone's financial status — and willingness to take risk — varies depending on their asset mix. Now is an excellent moment to prepare for some hazards.

"If you know, for example, if the portfolio goes down by 10% you're going to move to cash, move to cash now before it's going to do that," Blanchett instructed. Government bonds also offer potential to generate returns that were not accessible two or three years ago, he added. When the market falls, having a cash buffer to fall back on can assist you avoid selling investments and locking in losses. Lester believes that having two to three years of spending in cash can be a good strategy for retirees and near-retirees.

What is my source of income?

Having guaranteed income can help to mitigate the impact of market swings on your portfolio. Most retirees rely on Social Security for regular monthly benefits. However, if you claim at the earliest possible age—62—your retirement benefits will be permanently decreased. Waiting until full retirement age — normally 66 to 67, depending on your birth date — allows you to get 100% of your earned benefits. If you wait any longer — up to age 70 — your benefits will increase by around 8% per year. "Now more than ever, delaying claiming Social Security is just a spectacular thing to start with," she remarked.

Individuals may also want to consider purchasing an annuity, which is an insurance plan that provides monthly income streams in exchange for an upfront lump sum payment made to an insurance company. "The higher interest rates are, the better the payment stream is off an annuity," said Lester, who also works as an education fellow for the Alliance for Lifetime Income, a charity that educates consumers about annuities.

"Rates are likely to drop in the future, and lower interest rates are going to likely result in lower payouts for annuity," Blanchett pointed out. "So addressing this now vs. later will likely lead to more income, a higher return." Certain products, such as multi-year guaranteed annuities and other fixed annuities, can provide assured returns in a tax-efficient manner for older Americans, he added.

Finally, retirees should stay informed about policy changes that may affect their financial planning. Government decisions on healthcare, taxes, and social security can have direct impacts on retirement strategies. Keeping abreast of these changes and adjusting plans accordingly can help retirees maintain financial stability. Before acquiring an annuity, consumers should conduct due diligence to determine whether the product is appropriate for their financial situation. Consulting with a respected licensed financial professional might be beneficial.