Low Interest Rates Puts Future Retirees’ Golden Years in Peril

An article in the May 20th issue of the Wall Street Journal described the current trend of investors chasing yield through riskier investments. The reason is the historical low interest rates earned from safer investment vehicles like Treasury securities. With the onset of the 2008 recession, the Federal Reserve reduced short-term interest rates to basically zero. The hope was it would spur personal consumption and business investment and restore the economy to pre-recession employment levels and growth rates. When this did not happen, the Fed resorted to what it called Quantitative Easing, a process in which they purchased billions of dollars in Treasury bonds to reduce long-term interest rates. Continue reading

Advice to Young Adults: Start Saving Now

An article in this past weekend’s The New York Times, summarizes a sound—and fairly simple—recommendation by financial advisor William Bernstein on the best way for the young to prepare for retirement. To paraphrase an old saying about voting in Chicago: Save early and often. Mr. Bernstein expands on this in a free e-book called If You Can. Though the book is geared toward those just entering the work force, the idea is applicable to any worker of any age.

For a person to be fully prepared for retirement, Mr. Bernstein says that he or she must start saving a minimum of 15 percent of their income each and every year starting in their 20s. He also recommends that one invest in just three index funds in equal proportions: an international stock fund; a domestic stock fund; and a bond fund. Mr. Bernstein points out another important piece of advice—minimize the fees paid out to financial advisors. For every dollar paid out today lowers one’s portfolio by many multiple dollars at the time of retirement.

The key to all of this is how to get people to save. It is human nature to discount the future, relative to the present. One always thinks they will have time to save at a later date. According to the article, nearly 50 percent of the current workforce doesn’t have enough savings to maintain a pre-retirement standard-of-living. Maybe the incentive to save will be there when the young witness first-hand as the baby-boomers retire in mass and their standard-of-living plummets.

A Modest Step to Help Low Income Savers

Saving money for the long term can be extremely complicated for low-income people who change jobs often. They typically don’t have employers who set up 401ks for them, and if they do the amounts are usually small, the administrative fees eat up a good chunk of what they have in there, and it becomes a hassle to transfer them from employer to employer. It’s easier to simply cash them out when given the opportunity–and they usually have entirely valid reasons for doing so.

There have been a number of attempts to make it easier for this cohort to save for retirement. While it may not materially boost the amount of capital in the economy, there are all sorts of benefits to people having something tangible set aside for retirement.

While we usually oversell the societal benefits of home ownership, we also underestimate the salutary impact of people having a retirement account with a material amount of money in it. Anything that gets people willing to forego immediate gratification and think more strategically about work, family, and life is a boon for everyone involved. An easily accessible and portable retirement account and such long-term thinking are mutually reinforcing.

The administration’s recently introduced myRA plan may not be perfect –we would quibble about the choice of account—but it’s an improvement upon the status quo. The G fund might be in the doldrums now but that won’t always be the case, and we can expect a political backlash that would ensue if these investors had some of their savings in the small-stock fund and it fell 20% in a future recession.

There are also folks who quibble about the $15,000 limit, at which point the account becomes a regular IRA, but there’s no strong argument for a different limit. The line has to be drawn at some point, and it might as well be $15,000.

A recent example shows what these types of accounts can do. Ray Boshara, currently an economist at the St. Louis Fed, wrote about the transformative effects of the savings accounts that were part of the Harlem Children’s Zone experiment in New York City. These accounts basically offered participants a 100% rate of return on their savings, and those participants–all of whom were part of low-income families that qualified for food stamps–managed to save a lot. In fact, in some instances the average savings rate exceeding 20%. That’s higher than almost any other cohort in America save, perhaps, the 1%. Not surprisingly, these families (and their children) excelled in the program.

Savings is good. It causes people to think about the long term, promotes financial security, and benefits everyone involved. Let’s help people do more of it.


Tom CaponeTom Capone is an associate with the Savings and Retirement Foundation as well as an analyst for Capital Policy Analytics, a consulting firm based in Washington, D.C.. His past experience includes working for Congressman Kevin Brady, chairman of the Joint Economic Committee, and formerly as a research analyst for the Center for Data Analysis at the Heritage Foundation. He has a B.A. in public policy from St. Mary’s College of Maryland.

Review of Paper: “Investment Performance, Inflation, and Taxes: Redefining History’s Bear Markets”

In a paper in the summer 2013 edition of The Journal of Retirement, Matthew Kenigsberg discusses the importance of inflation and taxes in evaluating rates of return on retirement savings (he will present the paper at the monthly Savings and Retirement Foundation lunch on October 25). Kenigsberg’s thesis is that financial analysts need to look at pretax nominal returns, taxes, and inflation; rather than total returns alone. Continue reading

New America Foundation- Arizona State Panels on Longevity and Public Policy

Last Friday, Slate.com, New America Foundation, and Arizona State University hosted a series of panels discussing the implications of increasing life expectancy on public policy, retirement, and family planning.

Savings defaults, auto-enrollment, and financial literacy were hot topics. Nudges, “guardrails,” and redefining “retirement” are discussed at length.

Life Expectancy Rate and Impact on Retirement (~40 minutes)

Senate Special Committee on Aging Worries about Baby Boomers’ “Golden Years”

Yesterday, while the Senate as a whole was waiting out Senator Cruz during his negotiated “filibuster” to move forward the continuing resolution to fund the government past September 30th, the Senate Special Committee on Aging took a little more than an hour and half during the afternoon to reexamine the increasing concern among Baby Boomers that they won’t be able to retire at age 65, or if they do, not at the standard of living that they’ve grown accustomed to during their productive years.

Baby Boomers find themselves nearing the Social Security full-benefit retirement age much less financially prepared than they hoped they’d be. The percentage of Boomers carrying debt ages 51 to 62 has risen six percentage points to 70 percent since the early 1990s, and the average debt has risen four-fold to $28,300 — all while the changing landscape in company provided retirement benefits has left many unexpectedly working into years they’d previously set aside for leisure.

There was surprisingly little mention of the dire situation that the Social Security Trust Fund currently finds itself in, or that since the 1950s the average American worker is actually retiring earlier- now 62 years old compared to 68 y/old. Not to mention life-expectancy has risen from 72 y/old to early 80s for workers retiring now–meaning Baby Boomers are expecting to spend approximately a third of their adult life in retirement. Although the remedies offered up for securing Baby Boomers’ golden years were nothing new– greater financial literacy, mandatory life insurance plans, auto-enrollment in company sponsored savings plans, and modifications to Social Security– the discomfort in addressing our own notions of what retirement should be was obvious.

“We’re coming to some tough conclusions here… Work longer is one conclusion. That certainly wasn’t the way it was in the previous generation,” said Chairman Bill Nelson, Senator from Florida.

U.S. Saving and Investment Data Shows Looming Economic Problems

One of the fundamental equations in macroeconomics is savings = investment.  This makes sense—one can’t invest (i.e. borrow) more than what is available in savings.  The Bureau of Economic Analysis (BEA) recently released revised data on aggregate savings and investment in the U.S. economy dating back to 1929.  The data shows a looming investment problem on the horizon. Continue reading

California’s “Secure Choice” Proposal

With a rash of studies indicating major shortfalls in the nation’s retirement savings, there has been no shortage of proposals to reform pensions, both public and private, and to induce a greater savings rate for younger workers. As Baby Boomers move into retirement, the lopsided nature of the workforce to retiree ration means that now, more than ever, people need to be mindful of where the money for their twilight years is going to come from.

One such proposal is California’s Secure Choice Retirement Savings Program, a mandatory savings initiative that would require private sector employers to put aside three percent of their workers’ pay into a retirement account guaranteed by the government. The proposal is modeled, in part after mandatory savings programs that exist in other countries, and which have widely been touted as successful, with Australia being a particularly noteworthy case. Although secure choice has not yet passed the California legislature, it has the support of Governor Jerry Brown and other states are already beginning to show an interest in adopting similar ideas.

Naturally, the idea of a mandatory savings program is not without controversy. Critics of the idea point out that Social Security was also supposed to be a guaranteed retirement account, but that that promise was broken long ago, leaving the program struggling for solvency. They argue that another entitlement program isn’t the answer, and there are also concerned about an already paternalistic state telling private sector workers and employees what to do with their own money.

Supporters of Secure Choice, on the other hand, are quick to answer that there is an ability to opt out of the savings requirement, and that the program only affects private sector employers who do not already offer some type of retirement account. Three percent of one’s wages is not going to be a sufficient sum on which to retire, but is intended merely to supplement Social Security and any other private savings workers have accrued throughout their careers.

Secure Choice is not the only option on the table to increase American retirement savings; Michigan has been experimenting with a prize-based approach that shows some promise. But California’s bold initiative is one of the more dramatic and attention-getting ideas. If it proves successful, it could end up spreading rapidly, changing the savings landscape significantly in a relatively short period of time.

New Data on U.S. Savings Rate

Last week the Bureau of Economic Analysis (BEA) released revised data on the U.S. economy dating back to 1929.  Among the data revised was personal savings—as measured as a percent of disposable income.  The new data shows that savings was slightly higher over the past forty-three years than first thought.  The average annual revision was 1.3 percentage points. Continue reading

Analysts Differ on Ways to Shore Up Retirement Security

In response to new studies illustrating how inadequate America’s retirement savings accounts really are, combined with President Obama’s proposed budget calling for a cap on employees’ contributions to their 401k plans, several analysts are launching new proposals to combat the retirement savings shortfall.

Chris Farrell, on Bloomberg News, outlined a suggestion to remove the tax incentives from 401k plans and IRAs, and replace them with an automatic enrollment program. This, he argues, would increase aggregate retirement savings while simultaneously reducing costs to the federal government.

Farrell is not the only one who thinks mandatory savings could be answer to the retirement crisis. Alicia Munnell, director of the Center for Retirement Research, has stated that voluntary savings plans are inadequate to meet the needs of modern retirees, and columnist Dan Kadlec has pointed out that mandatory retirement savings seem to have rescued Australia from a similar dilemma.

Other proposals involve increasing 401k contributions, setting up a Federal Retirement Board or allowing people to simply be “bought out” of their Social Security plans early.

However, some advocates are pushing back against talk of eliminating the tax incentives from current retirement plans, demonstrating that 71% of the money from such incentives flows to families making less than $150,000 a year. A report from the American Society for Pension Professionals and Actuaries concludes that these incentives are the most efficient way to help the average American save for retirement, and that reductions in these incentives would damage the retirement security of workers. About two-thirds of workers currently hold jobs that offer retirement plans, the report says, and incentives such as these are necessary to maintain, and indeed increase that number in the future.

Another Example of Unintended Consequences

Arnold Kling has a post at the AEI blog entitled “Regulating Risk.”   He answers the question of why long-term interest rates are so low.  He writes:

It is not “quantitative easing.” It is not a mysterious shift in preferences among savers. It is that banks, which enjoy enormous advantages in attracting funds from savers due to actual and perceived protection offered by governments, have a strong incentive to direct these savings into financial instruments that their regulators have designated as having little or no risk. Risk-based capital regulations may be ineffective at promoting bank safety. But they are plenty effective at allocating capital away from productive private investments and toward government bonds.

Politicians are never satisfied with either leaving things alone or making incremental changes to measure their impact. Rather they pass (or attempt to pass) massive, comprehensive legislation because they dream of having their name on a bill which will be discussed in high school government classes twenty years from now.

Haircuts for the Wrong Heads

Ike Brannon on savings and the Cyprus banking crisis:

Haircuts for the Wrong Heads

I was taken aback when the E.U. first suggested that the Cyprus government should impose a haircut on all deposits in the country’s banks, even those below the insurance cap of 100,000 Euros. The E.U. ultimately relented on small deposits, but at the cost of bigger depositors losing an even greater proportion of their money — as much as 30% for the biggest deposits.

While it may be difficult to pity the Russian kleptocrats who will (ostensibly) take the brunt of this hit, it’s not hard for someone in the U.S. to feel a twinge of sympathy for the Cypriot businessman who just took a major hit, most likely at the same time his business is imploding. Americans are no doubt giving silent thanks that it didn’t happen here.

Maybe we should give thanks for something else, however. The always astute Chris Whalen pointed out on the financial blog Zero Hedge that U.S. depositors received a similar haircut in the last five years, courtesy of the Federal Reserve, via record low interest rates on savings.

The Fed’s unprecedented monetary expansion has caused interest rates to plunge. Most savings accounts pay less than 0.5% interest these days, and even the typical CD pays well below 1%. In 2007, average one-year CD rates were around 5.5% when they began their downward plunge. At 5.5%, someone holding the maximum insured deposit of $250,000 would today have over $330,000, after compounding. Instead, in reality they have only $255,000, i.e. $75,000 less, because of lower interest rates. A 20% haircut would be a pleasure compared to what the Fed has done to returns.

How have people responded to low interest rates? By finding other places to park their money, like real estate. Housing prices are booming again, up smartly in most regions of the country in 2012. This has been driven by investors buying up clumps of houses and renting them out, which is precisely goal of the Fed’s exercise.

But does the Fed really deserve the lion share of the blame for the effective haircut on U.S. depositors? No. Congress, rather, is the party most responsible for this situation.

The Fed resorted to its massive monetary expansion and stuck with it largely because Congress could not bring itself to address our moribund real-estate market. When over a quarter of all homeowners owe more on their mortgages than the underlying values of their homes, it serves as a tremendous drag on the economy. People in these mortgages could not refinance or sell their homes to move or do much of anything, and the economy suffered as a result. Something had to be done.

Nevertheless, Congress felt that the notion of someone walking away from a mortgage was somehow immoral (the exact words that Treasury Secretary Hank Paulson used) and as a result we waited around and watched millions of homeowners slowly and reluctantly realize that they could, in fact, walk away from their mortgage without anything terrible happening to them. Those abandoning their mortgages could even live in their house for months (or longer) not paying anything while their default worked its way through various legal channels. Not surprisingly, the economy sputtered in the meantime.

A mortgage cramdown in the context of an individual Chapter 13 bankruptcy reorganization would have sped up the resolution of our housing morass by letting the people living in a house with an underwater mortgage remain in that house and retain ownership. The truth is that someone holding a $400,000 mortgage on a house worth $300,000 will only ever get $300,000 for that house. The important question is — who pays that $300,000 — the current owner or a new owner, and after how many years of stasis?

Ultimately, notions of morality got in the way of the economically expedient — just as they did during the Great Depression — and the federal government sat on its hands. Sometimes, doing nothing is the right answer — when it comes to spending tens of billions of dollars on high-speed rail in Florida or rural California, for instance — but the housing crisis needed our government to act with haste. The banality uttered around D.C. that economic growth will cure what ails the housing market neglected the inconvenient fact that it served as an effective barrier to growth.

It’s probably too bad that some of the most egregious Wall Street financiers who bet against a financial collapse did not have to pay a bigger price for their perfidy — not because it would help quench our desire for vengeance but because it has set a terrible precedent for future reckless gambles to get bailed out as well.

The home-mortgage market won’t be at risk of a relapse soon, not with mortgage lenders and the buyers of MBSs demanding high credit scores and substantial down payments before lending money. But Congress managed to inflict a version of Protestant morality on housing speculators, while simultaneously impoverishing millions of homeowners. And in the meantime, the family that’s been diligently setting aside 5% or 10% of its income in the hope of buying a first home (or a bigger home) for its family, has treaded water. Naïfs.

So go ahead and cry for the Cypriots, but save a few tears for homeowners in the U.S.

Originally published at the George W. Bush Institute’s 4% Growth Project

Retirement Accounts are Leaking

The Senate Health, Education, Labor and Pension (HELP) Committee held a hearing on Tuesday to investigate the causes, incentives, and possible remedies to workers’ withdraws and borrowing of retirement assets for non-retirement costs. There is a large percentage of American workers that are saving for retirement, but they don’t have savings for other milestone “purchases” (ie buying a home or paying for college). These non-retirement withdraws are called “leakage.”

Only two percent of savers withdraw for catastrophic need, this is “leakage”, but wouldn’t be considered as abuse of retirement savings by any reasonable measure. However, borrowing against retirement savings has a varied degree of “necessity,” and preventing the use of these accounts for non-essential borrowing should be a goal of any retirement policy. “Cash outs” during job transitions are the major culprit for mismanagement of retirement finances. Cash outs happen most often when retirement accounts have relatively small investments, leaving workers with frequent job change at a systematic disadvantage for retirement preparedness. Creating incentives to roll-over these accounts, or allowing “cashing in” these withdraws into a new retirement account should be a simple process to avoid liquidation and spending of retirement assets as a result of a job change. Continue reading

Retirement confidence lags leading indicators

Admitting you have a problem is the first step in recovery. It’s not news that people are living longer than they used to, and it’s certainly not news that workers often underfund their retirement expectations. What is news, is workers are starting to realize in larger numbers that they likely won’t be able to afford retirement at 65 if they continue saving–or not saving– as they have in the past. The Employee Benefit Research Institute (EBRI) just released its 23rd annual Retirement Confidence Survey, and it shows worker confidence resting on last year’s record low sentiment.

The economy has shown signs of improvement in the last year–albeit not overwhelming improvement–and one would think that like the stock market, retirement confidence would take the opportunity to show some exuberance. Not the case this time. The poor economy of the past few years seems to have woken up workers to the practical uncertainties of retirement, and its mounting cost. EBRI suggests that regardless of whether the actual savings and investment rate increased or decreased, this lowered retirement confidence is likely a result of the Great Recession as workers faced prolonged periods of unemployment, reduced wages, and lower rates of return (or more likely losses) during that period.

“One reason that retirement confidence has remained low despite a brightening economic outlook may be that some workers may be waking up to a realization of just how much they may need to save. Asked how much they believe they will need to save to achieve a financially secure retirement, a striking number of workers cite large savings targets: 20 percent say they need to save between 20 and 29 percent of their income and nearly one-quarter (23 percent) indicate they need to save 30 percent or more.”

In other words, workers have been badly shaken during this economic doldrums, and the lasting affect is workers rude awakening to previous under-saving. We’ll have to wait and see whether or not the fear translates to long-term improved savings rates.