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.

1. 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.

2. 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.”

During low-return periods, the tax advantages of saving in 401(k) plans are relatively less attractive, considering the gain from saving in pretax plans is lower.

Also, the paper notes that the return on assets in the retirement account are lower in a low return environment.

3. Low interest rates drive workers to claim Social Security benefits later.

According to the paper, workers claim Social Security later during times of low interest rates, so they can “take advantage of the relatively high payoff to deferring retirement under current rules.”

When the long term interest rate falls to zero, women claim about 0.4 years later, and men almost a full year later, the paper finds. The paper also notes that claiming at the earliest possible age of 62 declines quite notably, more so for men but also for women.

4. When rates are low, people draw down their 401(k) assets sooner.

The paper finds that people finance consumption relatively early in retirement by drawing down their 401(k) assets sooner during periods of low returns.

“When the real interest rate is low, a worker can delay claiming Social Security in exchange for higher lifelong benefits, and the cost of taking more from his retirement count to support consumption is lower,” the paper states.

Alternatively, when expected returns are high, the worker can claim early Social Security benefits without needing to withdraw as much from his retirement assets which continue to earn higher returns for a while longer.