Low Interest Rates Affect Retirement Readiness

A new study by the Employee Benefit Research Institute (EBRI) quantifies the impact of a sustained low-interest-rate environment on employees’ retirement readiness.

Using its Retirement Security Projection Model (RSPM), the EBRI found that more than a quarter of Baby Boomers and Gen Xers who would have had adequate retirement income under historical averages return assumptions end up running short of money in retirement if today’s low interest rates are assumed to be a permanent condition.

“There appears to be a very limited impact of a low-yield-rate environment on retirement income adequacy for those in the lowest pre-retirement income quartile, given the relatively small level of defined contribution and IRA assets and the relatively large contribution of Social Security benefits for this group,” said Jack VanDerhei, EBRI research director and author of the study. “However, there is a very significant impact for the top three income quartiles.”

The impact of low interest rates is lessened if the rates are temporary, said VanDerhei. For example, when retirement readiness is based on the assumption that retirement income/wealth must cover 100% of expenses, then 36% of Gen Xers with no future years of defined contribution eligibility would be predicted to have adequate retirement income if the zero-real-bond-return assumption is expected to last only for the first five years after retirement, compared with 35% if that environment persists for a decade. In contrast, 33% of this group would be predicted to have sufficient money in retirement if the zero-real-bond-return scenario is assumed to be permanent.

VanDerhei said that the impact of low interest rates is magnified by years of future eligibility for participation in a defined contribution plan. Moving from the historical-return assumption to a zero-real-interest-rate assumption results in an 11 percentage-point decrease in simulated retirement readiness for Gen Xers who have one to nine years of future eligibility, but that gap widens to a 15 percentage-point decrease in retirement readiness for those with 10 or more years of future eligibility.

He added that for the younger Gen Xers, the decline in retirement adequacy would range from 4 percentage points under a five-year, low-yield-rate environment, to 7 percentage points if rates remain depressed for 10 years, and 11 percentage points if those low rates are permanent, assuming they have one to nine years of remaining eligibility in a defined contribution retirement plan (such as a 401(k)).

The full report can be found in the June 2013 EBRI Notes under the title “What a Sustained Low-yield Rate Environment Means for Retirement Income Adequacy: Results From the 2013 EBRI Retirement Security Projection Model,” which is available at www.ebri.org.The EBRI is a nonpartisan, nonprofit research institute that focuses on health, savings, retirement, and economic security issues.