Using its Retirement Security Projection Model, EBRI found that for 401(k) participants (assuming no defined benefit accruals and no job turnover), more than one in 10 current participants will likely hit the proposed cap sometime prior to age 65, even at the current and historically low discount rate of 4%. And when the simulation is rerun with higher discount rate assumptions that are closer to historical averages, the percentage of participants likely to be affected by the proposed limits increases substantially.
“While relatively few 401(k) participants would be affected by this at first, the impact would likely spread over time, perhaps substantially, depending on interest rates and whether individuals also participate in a defined benefit retirement plan,” said Jack VanDerhei, research director at EBRI and author of the study.
EBRI estimates that there’s a growing gap between what people are saving for retirement and what they actually need. VanDerhei says that the gap, which includes income to pay for uninsured health care costs, amounted to $4.6 trillion in 2010. Last year, it grew to $4.8 trillion.
The Employee Benefit Research Institute, on the other hand, found that shifting interest rates have a substantial impact on retirement adequacy. Without getting into an extended assessment of its retirement model versus the one developed by the Center for Retirement Research, it is important to note that the models do differ.
The EBRI model, for example, does not assume people annuitize their assets at age 65 but that they spend their Social Security and any traditional pension income and then withdraw money as needed from their 401(k)s and individual retirement accounts. If they run out of money, EBRI assumes they convert their home’s equity into a lump-sum distribution and spend these funds as needed.
Some people “have termed 401(k)s a failed experiment,” said Jack VanDerhei, a research director at EBRI and author of the report.
“But it’s just not what the evidence is suggesting,” he said.
For example, lower-income workers who are now aged 25 to 29 and who remain eligible for their retirement plan for 30 to 40 years end up with a 15 percentage point higher income-replacement rate at retirement with a 401(k) than with a traditional pension plan, according to the study’s median finding for that scenario.
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)).
“If these rates stay as low as they are, then a lot more people are going to be hurting,” says Jack Van Derhei, research director at the Employee Benefit Research Institute. The non-partisan outfit estimates that if current conditions persist, nearly three in five baby boomers will be at risk of running short of money in retirement. “There are going to be many luxury items that will simply have to be eliminated,” for retirees to make ends meet.
At the same time, the return people can hope to earn on their assets has fallen, particularly for those who switch into bonds or annuities to guarantee a fixed income. The average yield on U.S. government, corporate and mortgage bonds stands at about 2.4%, while stock-market valuations suggest a long-term return of about 6%. At those levels of return, some 59% of people aged 56 to 62 will be at risk of not having enough money to cover basic living and health-care costs in retirement, estimates Mr. Van Derhei. If market returns are higher—8.9% for stocks and 6.3% for bonds—the picture isn’t a lot better: The percentage at risk falls to about 47%.
The low-interest-rate environment “has an extremely large impact on failure rates,” according to a soon-to-be-finished study by the Employee Benefits Research Institute.
EBRI research director Jack VanDerhei discussed the research, which he plans to finish within a month, on Thursday at the group’s policy conference in Washington. Other retirement planning experts also gave their takes on how the current interest rate environment is affecting workers’ retirement savings.
While there’s a “limited impact” on retirement income adequacy for those in the lowest income quartile and a “very significant” impact for the top three income quartiles, VanDerhei said that overall, “25% to 27% of Baby Boomers and Gen Xers who would have had ‘adequate’ retirement income under historical averages end up running ‘short’ of money in retirement if today’s rates are assumed to be a permanent condition.”