How does an environment of persistent low returns influence saving, investing and retirement behaviors?
A new paper from National Bureau of Economic Research explores how persistent low returns would shape workers’ and retirees’ decision-making regarding accumulation and retirement patterns.
“Persistent low returns can compel workers to save more and invest differently when allocating across stocks and bonds. Moreover, the low interest rate environment can also change retirement decisions, especially regarding how long to work and when to claim Social Security benefits,” according to the paper, which was written by The Wharton School’s Olivia Mitchell and Goethe University Frankfurt’s Vanya Horneff and Raimond Maurer.
The paper – using a calibrated lifecycle dynamic model with realistic tax, minimum distribution and Social Security benefit rules in both a low return and “normal” environment – determines four ways in particular that low returns could affect retirement and saving behavior.
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People are predicted to save less during periods of low returns.
The paper finds that workers build up less wealth in their retirement plans in a low return environment.
Looking at a 0% yield scenario, middle aged women (age 55-64) optimally accumulate an average of about $88,200 in their 401(k) plans. Meanwhile, in a 2% yield scenario, they average one-third more, or $117,700 at the same point in their life cycle.
The paper finds similar results for men, too. Middle-aged men accumulate $83,200 in the zero-rate environment, and 45% more ($120,600) in the 2% interest rate scenario, according to the paper.
Interestingly, the paper finds that opposite happens to assets held outside the tax-qualified retirement plans.
“That is, women age 45-54 hold $16,600 in liquid stocks and bonds when the interest rate is Zero, but only $9,800 in the two percent interest rate scenario,” the paper states, noting the same effect also applies to males.
Low rates change where people save.
In the context of a zero return environment, the paper finds that workers devote more of their savings to non-retirement accounts and less to 401(k) accounts. According to the paper, this is because “the relative appeal of investing into taxable versus tax-qualified retirement accounts is lower in a low return setting.”