Though the Federal Reserve Bank only slightly raised interest rates, higher rates could significantly affect companies sponsoring a retirement plan as well as their employees participating. But the new is both good and bad as detailed in a recent article by SHRM.
Higher interest rates will mean higher returns on products like money market funds which have experienced microscopic returns over the past decade of low interest rates. But consumers and business who will have to pay more to borrow money could result in lower buying power and earners affecting their ability to contribute to their plan and lower stock prices. In addition, higher interest rates could adversely affect long term bonds. Finally, participants with loans will have to pay them back at a higher rate.
The good news? DB (defined benefit) plans that calculate returns based on interest rates can use higher estimations when calculating funding requirements and will have to pump fewer assets into their plans which is especially important as market returns have been low to flat. Though loan repayments may be higher, it also means that participants will have more money in their accounts. And though long term bonds may suffer and lose some of their value, short term bonds could yield higher returns in a higher interest environment.
Bottom line is that the recent interest rate hike should have very little effect on participants in DC (defined contribution) plans as the increase was very low and most of these investors take a long term view. If rates were to increase substantially, the results might be different especially for long term bonds issued in a low interest rate environment. However, with recent global market volatility and a steady but not great U.S. economy, experts are not predicting precipitous interest rate hikes from the Fed.
