30-year bond yields just hit 5% for the first time since 2007. Cook Pierce shows what that means for two households with similar savings but very different retirement income structures.
This week 30-year bond yields crossed 5% for the first time since 2007. Wholesale inflation came in at 6%. A Federal Reserve official raised the possibility of rate increases. The interest rate environment that most retirement plans were built around is shifting in ways that deserve a clear look.
Two households below are looking at the same numbers this week. Same age. Similar savings. Very different questions running through their minds.
Carol and James are 62. They have been diligent savers for thirty years. Their combined retirement accounts sit at just over $900,000, almost entirely in tax-deferred 401k and IRA accounts. They have also accumulated a modest bond fund inside their investment portfolio, purchased years ago when yields were near historic lows.
When they see the 5% bond yield headline this week their first reaction is relief. Higher yields mean better returns on fixed income going forward. They are right about that. But there are two things their current structure has not fully accounted for.
The first is that bond funds and bonds held to maturity are very different things. Carol and James own a bond fund, which means they own a collection of bonds that are continuously traded. When interest rates rise, the market value of existing bonds in that fund falls. The yield on new bonds improves, but the value of what they already hold declines. They are experiencing the adjustment period before the benefit arrives.
The second is their withdrawal plan. Every dollar they draw from their 401k and IRA in retirement will be taxed as ordinary income at whatever rate exists at that time. With the government facing $75 trillion in unfunded Medicare and Social Security obligations, and with inflation driving the kind of fiscal pressure that typically leads to revenue discussions, the tax rate they will pay on those withdrawals is genuinely uncertain.
Carol and James are not in a bad position. But their retirement income is built almost entirely on opinions and market movements. What the market does. What Congress decides. What rates do next year. That is a lot of uncertainty for a plan that is supposed to provide certainty.
Patricia and Marcus are also 62. Similar savings history. Similar account balances. But eight years ago they restructured how their retirement income was built from the ground up.
A meaningful portion of their future retirement income comes from promise-based vehicles. An annuity that will generate a guaranteed monthly income stream regardless of what interest rates do. Whole life insurance cash value that grows without market exposure and can be accessed without triggering a taxable event. Government bonds held to maturity, not traded, which means the government's promise is the only thing that matters and that promise has always been kept.
Their surplus, the money above and beyond what they need for protected income, sits in market-based investments where they are genuinely comfortable with the risk because they do not need it to cooperate to fund their lifestyle.
When Patricia and Marcus see the 5% yield headline this week they see an opportunity. New promise-based vehicles structured at current rates will generate more guaranteed income than the same vehicles would have three years ago. The same environment that is creating uncertainty for Carol and James is creating an opening for Patricia and Marcus.
Same week. Same numbers. Two very different positions to be in.
The Cook Pierce Confidence Model organizes every financial asset into one of three categories.
Contract-based assets. Promise-based assets. Market-based assets.
Contract-based assets sit in the Protection column. Insurance policies. Legal documents. They transfer risk away from you.
Promise-based assets sit in the Sufficiency column. Annuities, whole life insurance cash value, government bonds held to maturity, bank CDs. They do not fluctuate with market sentiment. They deliver what was promised.
Market-based assets sit in the Surplus column. Stocks, mutual funds, traded bonds, real estate. They are driven by opinion. Their value is what the market says it is on any given day. They have no guaranteed outcome.
Most Americans have built their retirement almost entirely in the third column. Not because it was the right choice. Because it was the default. Because it was what the financial industry made easiest. And because nobody explained that there is a right order and that market-based assets belong third in it, not first.
Carol and James did not make bad decisions. They made the decisions most people make. Patricia and Marcus made the same decisions earlier in the sequence and added the columns underneath before filling in the third.
In a stable, low-rate, low-inflation environment the difference between the two approaches is noticeable but manageable. In an environment where rates are rising, inflation is persistent and the institutions managing both are in transition, the difference becomes something you feel every month.
We are currently in that environment. The decision window to address it is open. It will not stay open indefinitely.
