Why Low In­ter­est Rates Hurt Re­tirees


Re­tirees took an­other wal­lop from COVID-19 with the Fed­eral Re­serve’s an­nounce­ment two weeks ago that it ex­pects to hold in­ter­est rates near zero at least un­til 2023 be­cause of the pan­demic. That spells lower re­turns for re­tire­ment ac­counts, and it adds to the un­der­fund­ing of pen­sions that has wor­ried re­tirees for many years now.

The im­pli­ca­tions of lower re­turns on in­vest­ments are that re­tirees may save less, dip into their re­tire­ment sav­ings, and start col­lect­ing So­cial Se­planned, ac­cord­ing to Olivia S. Mitchell, Whar­ton pro­fes­sor of busi­ness eco­nomics and pub­lic pol­icy and ex­ec­u­tive di­rec­tor of the School’s Pen­sion Re­search Coun­cil.

“Low re­turns from the mar­ket are es­sen­tially a tax on re­tirees,” Mitchell said in a re­cent episode of the Whar­ton Busi­ness Daily show on Sir­iusXM.

“In the good old days, peo­ple used to lad­der their bonds, put a lit­tle bit of money in the mar­ket, and try to live off those re­turns,” Mitchell noted. (A bond lad­der refers to in­vest­ments in bonds with vary­ing ma­tu­ri­ties so that a port­fo­lio does not get locked into one type of bond.) “This is not fea­si­ble any longer. In fact, it’s even worse, be­cause those lower nom­i­nal re­turns are in many cases neg­a­tive in re­turns.”

Re­tirees may re­spond to the prospect of low re­turns by sav­ing less, Mitchell said: “If you’re not re­warded for de­fer­ring your con­sump­tion as much, then why do it?” Their sav­ings would fall re­tire­ment plans, she pre­dicted. The tax-qual­i­fied fea­ture is help­ful for those who aim to build an as­set base over time with in­ter­est and other re­turns on their in­vest­ments, while they are in rel­a­tively lower tax brack­ets. But now, “those build-ups are sim­ply not hap­pen­ing the way that peo­ple had planned,” she said. “If peo­ple do save, they’ll prob­a­bly save less over­all, and they will tend to save in other non-tax fa­vored ac­counts like bank sav­ing and check­ing ac­counts, where you’re lucky if you’re earn­ing half a per­cent­age point.”

Des­per­ate Times

Mitchell re­called that the 2008–2009 global fi­nan­cial cri­sis was “a bath of cold wa­ter for re­tirees, savers, pen­sion funds, in­sur­ance com­pa­nies, and so on.” How­ever, back then, an eco­nomic re­cov­ery fol­lowed, and “the la­bor mar­ket didn’t suf­fer as badly as it has dur­ing the

COVID-19 pan­demic, and for as long as it has,” she noted. Nowa­days, peo­ple’s per­spec­tives on re­tire­ment have changed and they are look­ing to work a lit­tle longer. “But the ques­tion es­pe­cially if you are an older worker?” she asked. In times of des­per­a­tion, some peo­ple may claim their So­cial Se­cu­rity ben­have planned — de­spite the fact that ev­ery year of de­lay could boost their

who don’t have any re­tire­ment sav­ings may have to go ahead and claim their [So­cial Se­cu­rity] ben­e­fits early, thereby ex­pe­ri­enc­ing a lower pay­out the rest of their lives.” Oth­ers that have lost some of their 401(k) sav­ings. Since April, they have been liv­ing off the gov­ern­ment’s “eco­nomic im­pact pay­ment” of $1,200 per in­di­vid­ual (an ad­di­tional $500 for each child), and the ex­panded un­em­ploy­ment in­sur­ance $2.2 tril­lion CARES Act. “Those have now ta­pered off, and Congress has not yet been able to come in ing bill,” Mitchell stated. Some peo­ple might con­sider op­tions like start­ing their own small busi­ness, but “this is a pretty tough en­vi­ron­ment in which to start a new busi­ness,” she added.

The 2020 CARES Act per­mit­ted in­di­vid­u­als to make early with­drawals up to $100,000 from 401(k) and 403(b) ac­counts with­out penal­ties. That hasn’t caught on so far be­cause the eco­nomic stim­u­lus pay­ments pro­vided money to cope with the pan­demic in the short term. How­ever, it may not be pos­si­ble to stave off early with­drawals from re­tire­ment ac­counts for too long, said Mitchell.

“Go­ing into the fall and win­ter, I do worry that [early with­drawals from re­tire­ment ac­counts] will be­come more of an op­tion if the la­bor mar­ket doesn’t re­cover,” Mitchell said. “And so, peo­ple might end up bit­ing off their nose to spite their face. Yes, they’ll get some cash, but what does it say about their re­tire­ment? Not much [that is] good.”

Also loom­ing is the pos­si­bil­ity that the So­cial Se­cu­rity Trust Fund could run out of money by 2029, rather than 2032 or 2034 as had been pre­dicted by Model af­ter the pan­demic struck. This could hap­pen “since peo­ple aren’t pay­ing the pay­roll taxes needed to po­ten­tially be­cause peo­ple are claim­ing [their ben - tant thing that needs to be done by pol­i­cy­mak­ers is bring So­cial Se­cu­rity back into sol­vency.”

For sure, pen­sion funds and in­sur­ance com­pa­nies have also been suf­fer­ing from low re­turns, Mitchell con­tin­ued. “Many of the state and mu­nic­i­pal pen­sion plans are prob­a­bly not go­ing to make it through this COVID cri­sis with any healthy amount of fund­ing.”

As it hap­pens, pen­sion plans are fac­ing “a per­fect storm” now, said Mitchell. They faced the sis with­out be­ing fully funded, but in later years “con­tin­ued to in­vest in risky as­sets, hop­ing to make it up in the great cap­i­tal mar­ket lot­tery.” Dur­ing the pan­demic, many pen­sion funds lost and the fore­casted low re­turns will make it “very vive,” she added.

In that seem­ingly hope­less sit­u­a­tion, Mitchell saw an­nu­ities as a “po­ten­tially ap­peal­ing” op­tion for re­tire­ment plan­ning. An­nu­ities are in­sur­ance prod­ucts that pay an in­come in re­tire­ment. Even if the in­sur­ance in­vest­ments held by an­nu­ity providers don’t make much money, in­vestors who out­live oth­ers in their pool will be el­i­gi­ble for sur­vival cred­its (also known as mor­tal­ity cred­its), she noted. She sug­gested that it is a good idea for em­ploy­ers and re­tire­ment plan spon­sors to in­clude an­nu­ities in 401(k) and 403(b) ac­counts, now per­mit­ted by the Se­cure Act since late 2019.

Mitchell’s re­cent re­search vol­ume on How Shape Sav­ing and Re­tire­ment may be down­loaded for free.

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