Interest Rate Risk

When financial headlines focus on stock market fluctuations, it’s easy to overlook a critical risk that affects CDs, bonds, Treasury securities, and other fixed-income investments: interest rate risk.

This type of risk is especially important for retirees. Many retirement income strategies depend on fixed-income investments to deliver consistent payouts and help reduce overall portfolio volatility.

Millions of Americans use fixed-income products to safeguard their nest egg or allocate funds for short- to medium-term goals. That’s why it’s essential to understand interest rate risk—it has a direct impact on a wide range of retirement plans.

So, what is interest rate risk—and how can it affect your retirement strategy? Let’s take a closer look.

How Does Interest Rate Risk Work?

Interest rate risk is the possibility that the value of a fixed-income investment will decline when interest rates change. This risk directly impacts the pricing of assets such as bonds and CDs.

Bonds are a common example used to illustrate this concept. Bond prices move inversely with interest rates: when rates rise, bond prices usually fall; when rates drop, bond values typically increase.

How Can Interest Rate Risk Affect Asset Values?

Consider this example: You buy a 10-year bond for $20,000 with a fixed rate of 2.5%. That bond will pay $500 annually until it matures.

Now imagine interest rates rise to 3%. New bonds issued at the same $20,000 investment would generate $600 per year. If you keep your original bond to maturity, you’ll still receive $500 annually—but you forgo the opportunity for higher returns elsewhere.

You might consider selling your 2.5% bond to reinvest at the higher rate. But since your bond now pays less than the new options, it’s less appealing to buyers. To sell it, you would likely need to discount the price—resulting in a loss.

This tradeoff is especially important for retirees who rely on fixed-income investments to preserve capital or support stable retirement income.

Scenario	Bond Details	Annual Interest	Outcome
Original Bond Purchase	10-Year Bond, $20,000 at 2.5%	$500	Earn $500/year if held to maturity
New Market Rate	10-Year Bond, $20,000 at 3%	$600	New bonds offer higher income
Sell Original Bond	2.5% bond vs. 3% market rate	—	Bond likely sold at a discount, resulting in a loss
Hold to Maturity	Original bond terms unchanged	$500	No capital loss, but lose potential $100/year in interest

An Answer to Interest Rate Risk for Retirement Income?

According to Dr. Wade Pfau, fixed and indexed annuities don’t experience interest rate risk in the same way as traditional fixed-income investments like bonds.

Although buying annuities during low-rate environments may lock in lower crediting rates, annuities offer different types of risk protection. While the underlying investments—such as bonds and mortgages—can still react to rate shifts, insurance companies use risk-sharing and actuarial models to help smooth out payments.

Life insurance companies also build in “mortality credits” when determining annuity payout options. These credits are based on expected life spans across a large pool of policyholders. This risk-pooling method can provide more stability than traditional fixed-income holdings managed by individuals or fund managers.

One Solution for Managing Interest Rate Risk

A fixed index annuity may be a strategic way to manage interest rate risk. These products don’t pay a guaranteed interest rate. Instead, they credit interest based on the movement of a financial index—such as the S&P 500 Price Index.

If the index rises, your contract earns a portion of that increase. If the index falls, your contract earns 0% for the period—without losing any previously credited interest.

What Sort of Growth Potential Might Indexed Annuities Offer?

Fixed index annuities are designed to offer stronger growth potential than traditional fixed annuities—while protecting your principal from market losses. Interest is credited based on the performance of a market index, such as the S&P 500 Price Index, but your account is never reduced due to index declines.

Growth is typically determined using features like a participation rate, cap, or spread. Here’s how each method works:

Crediting Method	Index Performance	Example Terms	Interest Credited
Participation Rate	+10%	80% Participation	8% (80% × 10%)
Cap Rate	+12%	6% Cap	6% (Capped at 6%)
Spread Fee	+7%	1.5% Spread	5.5% (7% − 1.5%)
Negative Year	−8%	All Methods	0% (No loss credited)

Even in a down market, fixed index annuities credit 0% rather than reducing your balance—ensuring any prior gains are preserved. Over time, this combination of growth potential and protection can help you build a more stable retirement income foundation without market exposure.

Guard Against Interest Rate Risk with Guaranteed Income

Like other annuity options, fixed index annuities can offer income you cannot outlive. You can choose from lifetime income, scheduled withdrawals, or a lump-sum payout.

Withdrawals made before age 59½ may incur a 10% IRS early withdrawal penalty unless an exception applies. All payouts are taxed as ordinary income.

Fixed index annuities can complement or even replace traditional fixed-income investments like CDs or bonds. To explore how these solutions might fit into your plan, consult with a licensed financial professional.

Investment Type	Sensitive to Interest Rate Risk?	Principal Protection	Growth Potential	Guaranteed Income Option
Bonds	Yes	No	Moderate	No
CDs	Yes	Yes (FDIC insured)	Low	No
Fixed Annuities	Indirectly	Yes	Low to Moderate	Yes
Fixed Index Annuities	Minimal	Yes	Moderate to High (Indexed)	Yes