Very low, short-term interest rates have also taken a substantial bite out of retirement income, according to a report from the Center for Retirement Research at Boston College. “How Has the Financial Crisis Affected the Consumption of Retirees?” found that what really matters, however, is the impact of the crisis on retirement consumption.

The report updates a recent study that found that the crisis had little effect on the consumption of retirees who had either very small or very large amounts of financial assets. In contrast, the broad middle class did suffer a drop in consumption. Some of these households invest mostly in short-term deposits, while others invest in a broader range of assets. Some attempt to live off the interest and dividends, while others follow the lifecycle model and draw down their wealth during retirement.

The report examined the impact of the crisis on financial assets, the impact of the crisis on retirees’ wealth and income, and how the crisis affected the consumption of two types of middle-class retirees. The report’s conclusion is that although lifecycle investors in balanced portfolios experienced relatively modest declines in consumption, the reductions for those attempting to live off the interest on short-term deposits were much greater. The results of the analysis for these specific behaviors represent extremes, with most people lying somewhere in between.

The financial crisis had varying effects on stocks, short-term deposits, and long-term bonds. The stock market declined dramatically from October 2007 to March 2009, and then gradually recovered its pre-crisis peak. But the true measure of the decline is relative to pre-crisis expectations of continued increases in stock prices. By June 30, 2013, stock prices were 24% below the level that might have been expected from the vantage point of October 2007. In contrast, after a blip, dividend payments on stocks recovered to hit record highs, as have corporate profits.

Impact and Consumption

The impact of declines in stock prices and interest rates on retirees’ consumption depends on the amount and composition of their financial assets, whether they plan to consume those assets during the course of their retirement, and the extent to which they rely on those assets to finance their consumption.

Roughly half of households were unaffected by the financial crisis. These are mostly households in the bottom two wealth quintiles who rely mainly on Social Security. But this group also includes households with generous defined benefit pensions who had little need to accumulate financial assets for retirement. It also includes a much smaller group of wealthy households, approximately the top 5%, who intend to pass on their assets to the next generation. These wealthy households invest mostly in stocks and long-term bonds. On balance, the dividend payments they receive from stocks will largely offset the reductions in bond interest as their existing holdings mature and are reinvested at lower interest rates. And any decline in the market value of their investments is irrelevant, because they have no plans to sell.

The other half of households, who are part of the broad middle class, were not so fortunate. Some of these households invest mainly in short-term deposits, whereas others hold a balanced portfolio including stocks and bonds. Some attempt to live off the interest, whereas others are lifecycle savers drawing down their capital during retirement. Most middle-class households lie between the two extremes.

The declines in stock prices and interest rates had little effect on very poor and very rich retirees. In between – from roughly the 50th to the 95th percentile of the distribution of financial assets – are the broad mass of the middle class who rely on investments to make the difference between living comfortably and just getting by. At one extreme are households who invest very conservatively, holding most of their financial assets in short-term deposits and attempting to live off the interest. Although they preserved their capital during the crisis, their investment income was wiped out for an extended period and will remain low until interest rates recover.

At the other extreme, lifecycle investors in a balanced portfolio, who plan to draw down their investments to finance their retirement, experienced much smaller declines in consumption but large, albeit temporary, reductions in wealth. Finally, most households combine some behavioral aspects from both of the illustrative household types, so their consumption losses will be smaller than those living off the interest in short-term-deposits but larger than those lifecycle investors with a balanced portfolio.

The report can be downloaded here.