If rates stay low, expect retirement security to take a hit

Interest rates have fallen far from the highs seen in the ’80s — and researchers are anticipating that they could stay low for a long time, which has implications for retirement security.

Some of the factors that have led to the current low-interest-rate environment could remain in play for years, according to an analysis of existing research recently published by the Society of Actuaries.

That would result in less money being available in defined-contribution plans as a result of lower bond returns, and less availability of guaranteed lifetime income products, the authors noted.

“First, if past retirement plans and saving decisions were based on expectations that interest rates and asset returns would be higher than they are now, savers may not have accumulated enough wealth to support planned retirement spending,” the report read. “Second, the worldwide decline in real interest rates makes it difficult, or impractically expensive, for savers to offset the impact of the decline by holding a globally diversified portfolio of interest-bearing assets.”

It’s a problem that affects people differently, based on income levels and savings. While low-income earners receive an average of as much as 85% of their retirement income from Social Security, they also have fewer options to save more of their income in response to low interest rates, work longer during retirement years or use the value of their homes to help provide retirement income, the report noted. By comparison, people who earn at least $78,000 annually get an average of just 18% of their retirement income from Social Security.

Because Social Security is affected by demographic trends and policy, it is much less influenced by interest rates than are DC plans, pension plans and life insurance products, the authors wrote.

“It generally is easier for high-income individuals to mitigate the impact of low interest rates through behavioral changes without making major lifestyle changes,” the authors of the recent paper wrote. Expenditures, particularly for necessities, often account for a smaller slice of income for high earners than lower earners, making it easier for the affluent to save more in response to low rates, the report noted.

“Low-income groups are less likely to own real estate, have less room to increase their savings rate, and may have less flexibility over when to retire,” the authors stated.

However, existing studies have reached different conclusions about how much higher interest rates could affect retirement security.

In response to prolonged low interest rates, annuity providers have adjusted their product lines and available benefits. Recently, there has been more development of annuities that emphasize investment returns, and the living benefits available alongside variable annuities are much less generous than they were more than a decade ago.

Several factors that affect interest rates will likely keep them low for some time, according to the paper. Growth in productivity, both globally and in the U.S. has been declining for decades, for example. Business-sector productivity growth in the U.S. averaged 2% annually between 1976 and 2005, falling to 1.25% from 2006 to 2015 and to just 0.5% between 2011 and 2015 specifically, the authors noted.

Further, factors such as shifting demographics, rising inequality, a global savings glut, a decline in the relative price of capital goods and other considerations could continue to keep interest rates low, according to the report.

“One implication of the research we reviewed is that if the low interest rate environment persists into the long run, defined-benefit pension funds and life insurers may have no choice but to reduce the guaranteed benefits for new workers and clients,” the paper stated. “For DC savers, reduced portfolio returns in the low-interest-rate environment will eventually translate into lower retirement income from DC savings, unless they contribute more or take on more risk in their investment portfolio.”