How does an environment of persistent low returns influence saving, investing andretirement behaviors?

A new paper from National Bureauof Economic Research explores how persistent low returnswould shape workers' and retirees' decision-making regarding accumulationand retirement patterns.

“Persistent low returns can compel workers to save more andinvest differently when allocating across stocks and bonds.Moreover, the low interest rate environment can also changeretirement decisions, especially regarding how long to work andwhen to claim Social Security benefits,” according to the paper,which was written by The Wharton School's Olivia Mitchell andGoethe University Frankfurt's Vanya Horneff and Raimond Maurer.

The paper – using a calibrated lifecycle dynamic model withrealistic tax, minimum distribution and Social Security benefitrules in both a low return and “normal” environment – determinesfour ways in particular that low returns could affect retirementand saving behavior.

1. People are predicted to save less during periods of lowreturns.

The paper finds that workers build up less wealth in theirretirement 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-thirdmore, or $117,700 at the same point in their life cycle.

The paper finds similar results for men, too. Middle-aged menaccumulate $83,200 in the zero-rate environment, and 45% more($120,600) in the 2% interest rate scenario, according to thepaper.

Interestingly, the paper finds that opposite happens to assetsheld outside the tax-qualified retirement plans.

“That is, women age 45-54 hold $16,600 in liquid stocks andbonds when the interest rate is Zero, but only $9,800 in the twopercent interest rate scenario,” the paper states, noting the sameeffect also applies to males.

2. Low rates change where people save.

In the context of a zero return environment, the paper findsthat workers devote more of their savings to non-retirementaccounts and less to 401(k) accounts. According to the paper, thisis because “the relative appeal of investing into taxable versustax-qualified retirement accounts is lower in a low returnsetting.”

During low-return periods, the tax advantages of saving in401(k) plans are relatively less attractive, considering the gainfrom saving in pretax plans is lower.

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

3. Low interest rates drive workers to claim Social Securitybenefits later.

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

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

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

The paper finds that people finance consumption relatively earlyin retirement by drawing down their 401(k) assets sooner duringperiods of low returns.

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

Alternatively, when expected returns are high, the worker canclaim early Social Security benefits without needing to withdraw asmuch from his retirement assets which continue to earn higherreturns for a while longer.