Few options for retirees when interest income sinks

THE BALTIMORE SUN

LOW INTEREST rates have pushed retiree Erwin Sekulow of Baltimore County to make a move in recent months that he hadn't planned - buy stocks.

Yields on money market funds are negligible, said Sekulow, 66, a retired Johns Hopkins University administrator. And when corporate bonds come due, it's difficult to find another investment that matches the old bonds' yield, he said.

Sekulow said he and his wife, Marianne, have turned to stocks - not willingly - and hope the stocks' prices and dividends won't drop.

"You are between a rock and a hard place," he said. "What happens is you're almost forced to go back into the equity market, which is not very comfortable."

Retirees relying on interest income have been taking a pay hit since Federal Reserve policymakers began reducing short-term interest rates in early 2001 to boost the economy. The 13th cut last month left rates at their lowest level since 1958, when Sekulow was a junior in college.

Last week, the average rate was 1.05 percent on a one-year certificate of deposit and 2.45 percent on a five-year CD, according to Bankrate.com.

And the average yield on money market funds was 0.58 percent, reported iMoneyNet. With rates so low, some fund companies are waiving their fees to prevent expenses from eating into investors' principal.

John Bacci, a financial planner in Linthicum, said low rates are a big complaint for clients.

Even $500,000 invested in a money market yielding 0.9 percent, one of the highest yields around, would only generate $375 a month, Bacci said.

"That's not what people had in mind when they retired," he said. "If you want to generate $2,000 a month, you need $2.5 million dollars in a money market."

Some financial experts worry that fed-up retirees may take on too much risk in pursuit of higher yields.

"People who are at most risk now are the conservative investors," Bacci said. "If you're earning 4 percent on a CD and it comes due and they offer you 2 percent, they are actually offering you a 50 percent reduction in your income. Then what do you do?"

Here are some suggestions for those wanting to boost income. All but one carry a potential loss of principal.

U.S. Savings Bonds. Principal is guaranteed. Rates are adjusted every six months, and currently pay 2.66 percent on Series EE and 4.66 percent on the inflation-protected I-bond. Income is not subject to state or local income taxes.

Investors must hold the bonds for at least 12 months, and forfeit three months' worth of interest if they redeem bonds within 5 years of purchase. Even then, investors cashing in the bonds after one year would still earn more in interest than in a money market fund, said Don Pederson, author of Savings Bonds: When to Hold and When to Fold.

Dividend-paying blue chips. These are shares in well-established companies with cash to pay dividends. An added advantage is that under the new tax law, dividend income is taxed at a rate of 15 percent, instead of the investor's ordinary income tax rate, which could be as high as 35 percent.

The new law has caused some companies to raise their dividends, said Richard Cripps, chief market strategist at Legg Mason Wood Walker Inc. in Baltimore.

For example, Bank of America and BellSouth raised their dividends last month, and SBC Communications declared an extra dividend of 10 cents a share.

Preferred stocks. These are a hybrid of a stock and bond, less volatile than common shares, and usually pay a fixed dividend. High-quality preferred stocks currently yield up to 6.5 percent, said Steve Athanassie, a financial planner in New Port Richey, Fla.

Like bonds, preferred stocks may have a "call" feature allowing the company to cash out investors early. Athanassie suggests looking for preferred stocks that can't be called for three to four years, so you have time to collect dividends.

Also, dividends for most preferred shares will not be taxed at the new 15 percent rate, and investors should ask the company how its dividends will be taxed, he said.

Short-term bond funds. These are less sensitive to interest-rate movements than long-term bond funds, and their loss of principal, therefore, will be less if rates spike upward, said Nancy Bryant, a financial planner in Lutherville.

High-quality, short-term corporate bond funds currently produce annual income of just over 3 percent, Bryant said. Investors can reduce risk further with ultra-short-term bond funds, whose holdings have an average maturity of less than one year and yield up to 2.3 percent, she said.

For those in high tax brackets, Virginia financial planner Thomas Grzymala recommends short-term municipal bond funds specializing in bonds issued by the investor's home state. That way, the income is not subject to federal or state income taxes, he said.

Real estate investment trusts. REITs own and manage properties, such as office buildings. They must distribute most of their taxable income each year to shareholders, so they tend to pay a healthy income stream. Distributions now average about 7 percent a year, experts said.

REIT dividends remain taxed as ordinary income under the new tax law. Experts also advise that small investors not tie their fortunes to one REIT, but buy a fund that owns many REITs.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or at eileen.ambrose@baltsun.com.

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