Interest rate cuts can be a mixed blessing

Earlier this month, the Bank of Canada announced its seventh consecutive interest rate cut since it began lowering rates in June 2024.

These rate cuts were widely expected as inflation continues to cool and economic growth shows signs of slowing.

While lower interest rates are welcome news for Canadians carrying mortgages and other debt, they present significant challenges for savers and retirees who rely on interest income.

The good news for borrowers is interest rate cuts are designed to stimulate economic activity by making borrowing cheaper and encouraging spending and investment. For Canadians with variable-rate mortgages, lines of credit or other forms of debt, lower rates mean reduced monthly payments and improved cash flow.

For example, a homeowner with a $500,000 variable-rate mortgage at five per cent interest would have been paying approximately $2,900 a month in principal and interest. If rates drop by one per cent, that monthly payment could decrease to around $2,650—a savings of $250 per month or $3,000 per year. These savings can provide much-needed relief for families feeling the pressure of high living costs and stagnant wage growth.

Lower rates also make it more affordable for prospective homebuyers to qualify for a mortgage, potentially giving the real estate market a boost. Additionally, those with outstanding personal loans, car loans, and credit card balances tied to the prime rate will see a reduction in their interest payments.

Tougher times for savers and retirees

While rate cuts are great news for borrowers, they are not as positive for Canadians who rely on savings and fixed-income investments to fund their retirement. Lower interest rates mean lower returns on savings accounts, guaranteed investment certificates (GICs), and bonds.

Retirees who have been counting on conservative investments to generate income may now find themselves facing shrinking returns. For example, a retiree with $500,000 invested in GICs earning four per cent would have been earning $20,000 annually. If rates drop to two per cent, that income would be cut in half to $10,000 per year.

Many retirement income strategies are built around the assumption that fixed-income products will provide reliable and predictable cash flow. When rates drop, retirees may have to draw down their capital more quickly than expected or shift to higher-risk investments to maintain their income levels.

Strategies to offset the impact of falling rates

While retirees and savers can’t control interest rates, they can adjust their financial strategies to minimize the impact of lower returns:

1. Diversify beyond fixed income – Retirees may need to look beyond traditional fixed-income products and explore dividend-paying stocks and balanced mutual funds or ETFs. These investment options can potentially provide a steady stream of income while offering potential for capital appreciation as well.

2. Ladder GICs and bonds – A GIC ladder involves spreading investments across multiple GIC terms (e.g., one-year, three-year, and five-year terms). This approach allows investors to benefit from higher rates when they become available while maintaining liquidity and some protection from rate declines.

3. Consider annuities – Annuities provide guaranteed income for life or a fixed period, which can help stabilize cash flow in retirement. However, with lower rates, the payout rates on annuities may not be as attractive—so it’s important to carefully compare options.

4. Shift to a total return strategy – Instead of focusing solely on income generation, retirees could consider a total return strategy that combines capital gains, dividends, and interest. This approach may involve increasing exposure to a mix of stocks and bonds to generate a more balanced return over time.

5. Delay RRSP withdrawals – If possible, retirees can delay withdrawals from their Registered Retirement Savings Plans (RRSPs) to allow their investments more time to grow. This strategy also allows them to take advantage of higher withdrawal limits and lower tax rates in later years.

6. Use a Home Equity Line of Credit (HELOC) strategically – For retirees with significant home equity, a HELOC can provide a low-cost borrowing option to cover short-term expenses or to supplement income during market downturns.

Balancing borrowing and saving in a low-rate environment

The Bank of Canada’s rate-cutting cycle reflects efforts to stimulate the economy and control inflation. While borrowers stand to benefit from lower interest costs, savers and retirees face a different reality—one where generating sufficient income becomes more difficult.

Retirees and those nearing retirement need to be proactive in adjusting their financial plans. Diversification, strategic withdrawal planning, and exploring alternative income sources can help offset the impact of falling rates. Working with a professional financial planner to adjust asset allocation and explore new income-generating strategies can make a significant difference in maintaining financial security through retirement.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.