what a sustained low-interest rate environment means for retirement income adequacy

® Employee Benefit Research Institute 2013® Employee Benefit Research Institute 20131

What a sustained low-interest rate environment means for retirement income adequacy

EBRI Policy Forum #72

May 9, 2013

Jack VanDerheiResearch Director, EBRI

[email protected]


Key points from today’s presentation

• A low interest-rate environment has an extremely large impact on failure rates when viewed in isolation

• But the impact is muted when included as part of the entire retirement portfolio

• There appears to be a limited impact on retirement income adequacy for those in the lowest (pre-retirement) income quartile

• Very significant impact for the top 3 income quartiles though

• Overall, 25-27 percent 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

• This assumes retirement income/wealth covers 100 percent of simulated retirement expense

• Impact significantly reduced at less stringent thresholds• For example, at an 80 percent of simulated retirement expense threshold, the

percentages are only 5-8 percent

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Previous Research: Finke, Pfau and Blanchett (2013)

• Analyzed failure rates for 4% inflation adjusted withdrawals over 30 years with a 50/50 asset allocation for three different asset return assumptions (arithmetic means):

• Historical averages: 8.6% real return for stocks, 2.6% for bonds• Real bond returns of 0: 6.0% real return for stocks and 0% for bonds

• keeping equity premium constant• Real bond returns = 5-year TIPS yield at the start of 2013: 4.6% real return for stocks and -1.4% for bonds

• Findings:• 6 percent failure rate for historical averages• 33 percent for real bond returns = 0• 57 percent for real bond returns = -1.4 percent

• Failure rate on this portion of the retirement portfolio is extremely sensitive to the bond return assumptions

• But what happens when other components are factored in?• Social Security, defined benefit, housing equity

• Given the existence of Social Security, most households will never run “out” of money in retirement • But there is a probability they will run “short” of money in retirement

• How does this vary by age, income and years of future eligibility for a defined contribution plan?

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Today’s results based on EBRI’s Retirement Security Projection Model® • Accumulation phase

• Simulates retirement income/wealth for Boomers and Gen Xers from defined contribution, defined benefit, IRA, Social Security and net housing equity

• Pension plan parameters coded from a time series of several hundred plans.• 401(k) asset allocation and contribution behavior based on individual administrative

recordso Annual linked records dating back to 1996 o More than 23 million employees in 60,000 plans.

• Retirement phase• Simulates 1,000 alternative life-paths for each household starting at 65• Deterministic modeling of food, apparel and services, transportation, entertainment, reading

and education, housing, and basic health expenditures.• Stochastic modeling of longevity risk, investment risk, nursing facility care and home based

health care.

• Produces a Retirement Readiness Rating™• Percentage of simulated life-paths that do NOT run short of money in retirement

• Supplemented with metrics on those with enough for 80 or 90 percent of simulated expenses

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® Employee Benefit Research Institute 20135

Early Boomers 8.6/2.6

Early Boomers

6/0

Early Boomers 4.6/-1.4

Late Boomers 8.6/2.6

Late Boomers

6/0

Late Boomers 4.6/-1.4

Gen Xers 8.6/2.6

Gen Xers 6/0

Gen Xers 4.6/-1.4

1 0.5511 0.4521 0.4019 0.5747 0.4722 0.4201 0.5718 0.4703 0.4308

0.9 0.1089 0.1489 0.1656 0.1122 0.1461 0.1604 0.0953 0.1235 0.1224

0.8 0.1518 0.1875 0.2074 0.1423 0.1808 0.1994 0.1357 0.1681 0.1852

5%

15%

25%

35%

45%

55%

65%

75%

85%

Impact of low-interest rate scenarios on Retirement Readiness Ratings(TM) by age cohort

Source: EBRI Retirement Security Projection Model® Versions 1750, 1755 and 1760Return assumptions are presented as arithmetic means for equities and bonds as real returns. Fees are not incorporated in this version of the model.

Percentage of simulated life paths that will NOT run short of money in re-tirement at various thresholds

Enough to cover 90% of simulated expenses

Enough to cover 80% of simulatedexpenses

Real bond ror = 0 5-year TIPS (start of 2013)

Enough retirement resources to cover 100% of simulated expenses

Historical averages


Lowest income quartile 8.6/2.6

Lowest income quartile

6/0

Lowest income quartile 4.6/-1.4

2 8.6/2.6

2 6/0 2 4.6/-1.4

3 8.6/2.6

3 6/0 3 4.6/-1.4

Highest income quartile 8.6/2.6

Highest income quartile

6/0

Highest income quartile 4.6/-1.4

100% 0.1643 0.1596 0.1593 0.5112 0.4315 0.4062 0.7033 0.5852 0.5317 0.8549 0.7531 0.6821

90% 0.1322 0.1341 0.1353 0.1318 0.1481 0.1434 0.103 0.15 0.1602 0.0626 0.1215 0.1582

80% 0.2471 0.247 0.2452 0.1725 0.1982 0.2087 0.1085 0.1609 0.1879 0.0549 0.0893 0.119

5.0%

15.0%

25.0%

35.0%

45.0%

55.0%

65.0%

75.0%

85.0%

95.0%

Impact of low-interest rate scenarios on Retirement Readiness Ratings(TM) by pre-retirement wage quartile

Percentage of simulated life paths that will NOT run

short of money in retirement at various thresholds



0 8.6/2.6

0 6/0 0 4.6/-1.4

1-9 8.6/2.6

1-9 6/0 1-9 4.6/-1.4

10-19 8.6/2.6

10-19 6/0

10-19 4.6/-1.4

20+ 8.6/2.6

20+ 6/0 20+ 4.6/-1.4

1 0.3855 0.3304 0.3099 0.5982 0.4884 0.4528 0.7335 0.5849 0.5231 0.8605 0.7072 0.6363

0.9 0.1091 0.1173 0.1167 0.1009 0.1221 0.114 0.0832 0.137 0.1381 0.0571 0.1193 0.1257

0.8 0.1847 0.2019 0.208 0.1299 0.1669 0.1789 0.096 0.1379 0.1702 0.0504 0.1096 0.1462

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%

Impact of low-interest rate scenarios on Gen Xer's Retirement Readiness Ratings(TM) by future years of eligibility for a de-

fined contribution plan

Percentage of simulated life paths that will NOT run

short of money in retirement at various thresholds



Previous results assumed a permanent shift to one of the alternative investment scenarios

• What happens if this is only a temporary phenomena?• The next slide models the same scenarios for a limited period of time

after retirement• 5 years• 10 years

• NB: no attempt to model short-term capital losses on bond portfolio that may result from increase in yields at this time

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0 8.6/2.6 0 first five

0 first ten

1-9 8.6/2.6

1-9 first five

1-9 first ten

10-19 8.6/2.6

10-19 first five

10-19 first ten

20+ 8.6/2.6

20+ first five

20+ first ten

1 0.3855 0.3643 0.3518 0.5982 0.5553 0.5296 0.7335 0.6811 0.6454 0.8605 0.8154 0.7751

0.9 0.1091 0.1138 0.1174 0.1009 0.116 0.1234 0.0832 0.1073 0.1225 0.0571 0.0774 0.098

0.8 0.1847 0.1915 0.1941 0.1299 0.1428 0.1514 0.096 0.1104 0.1224 0.0504 0.0682 0.0839

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%

Impact of low-interest rate scenarios during the first five/ten years of retirement on Retirement Readiness Ratings(TM) by fu-

ture years of eligibility for a defined contribution plan

Percentage of simu-lated life paths that will

NOT run short of money in retirement at

various thresholds



Summary


References• Finke, Michael, Wade D. Pfau, and David M. Blanchett, The 4% Rule is Not Safe in a

Low-Yield World” http://ssrn.com/abstract=2201323 • VanDerhei, Jack (November 2012).

All or Nothing? An Expanded Perspective on Retirement Readiness, EBRI Notes• VanDerhei, Jack (September 2012)

Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation, EBRI Notes

• VanDerhei, Jack (August 2012). Is Working to Age 70 Really the Answer for Retirement Income Adequacy? EBRI Notes

• VanDerhei, Jack (June 2012). Retirement Readiness Ratings and Retirement Savings Shortfalls for Gen Xers: The Impact of Eligibility for Participation in a 401(k) Plan, EBRI Notes

• VanDerhei, Jack (May 2012). Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model®, EBRI Notes

• VanDerhei, Jack and Craig Copeland (July 2010). The EBRI Retirement Readiness Rating:™ Retirement Income Preparation and Future Prospects. EBRI Issue Brief.

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http://ebri.org/pdf/notespdf/EBRI_Notes_11_Nov-12.Slf-Insrd-RetRdines.pdf

http://ebri.org/publications/notes/index.cfm?fa=notesDisp&content_id=5110



http://www.ebri.org/publications/notes/index.cfm?fa=notesDisp&content_id=5081




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Appendix: Brief Chronology of the EBRI Retirement Security Projection Model®

• 2001, Oregono Simulated retirement wealth vs. ad hoc thresholds for

retirement expenses

• 2002, Kansas and Massachusetts o Full stochastic retiree model: Investment and

Longevity risk, Nursing home and home health care costs

o Net housing equity

• 2003, National modelo Expanded to full national sample

• 2004, Senate Aging testimony (January)o Impact of everyone saving another 5 percent of

compensation

• 2004, EBRI Policy forum (May)o Impact of annuitizing defined contribution/IRA

balances

• 2006, EBRI Issue Brief (March)o Evaluation of defined benefit freezes on participants

• 2006, EBRI Issue Brief (September)o Converted into a streamlined individual version for

the ballpark estimate Monte Carlo

• 2008, EBRI policy forum (May)o Impact of converting 401(k) plans to automatic

enrollment

• 2009, Pension Research Councilo Winners/losers analysis of defined benefit

freezes and enhanced defined contribution employer contributions provided as a quid pro quo

• 2010, EBRI Issue Brief (April)o Impact of modification of employer

contributions when they convert to automatic enrollment for 401(k) plans

o 2010, EBRI Issue Brief (July)o Updated model to 2010, included automatic

enrollment for 401(k) planso 2010, EBRI Notes (September)

o Analyzes how eligibility for participation in a DC plan impacts retirement income adequacy

o 2010, EBRI Notes (October)o Computes Retirement Savings Shortfalls for

Boomers and Gen Xerso 2010, Senate HELP testimony (October)

o Analyzes the relative importance of employer-provided retirement benefits and Social Security

o 2010, EBRI Issue Brief (November)o The Impact of Auto-enrollment and Automatic

Contribution Escalation on Retirement Income Adequacy


Appendix (continued)

o 2011, February EBRI Issue Briefo Analyzes the impact of the 2008/9 crisis in the financial

and real estate markets on retirement income adequacyo 2011, EBRI policy forum (May)

o Analyzes impact of deferring retirement ageo 2011, July EBRI Notes article

o Analyzes the impact of the 20/20 limit recommended by the National Commission on Fiscal Responsibility and Reform

o 2011, August EBRI Notes articleo Analyzes value of defined benefit plans

o 2011, Senate Finance Hearing (September)o Analyzes the impact of modifying tax incentives for

defined contribution plans o 2012, Urban Institute Presentation (February)

o Analyzes whether Boomer and Gen X women will be able to afford retirement at age 65

o 2012, March EBRI Notes article o Analyzes employer and employee reaction to proposal

to modify tax incentives for defined contribution plans and simulates the expected impact on account balances at retirement age

o 2012, May EBRI Notes articleo Updates RSPM to 2012

o 2012, June EBRI Notes articleo Analyzes the impact of eligibility for participation

in a 401(k) plan on Gen Xerso 2012, August EBRI Notes article

o Provided additional evidence on whether deferring retirement to age 70 would provide retirement income adequacy for the vast majority of Baby Boomers and Gen Xers.

o 2012, September EBRI Notes article o Analyzed the impact of increasing the default

contribution rate for automatic enrollment 401(k) plans with automatic escalation of contributions.

o 2012 November EBRI Notes article o Reclassified the RRRs to provide additional

information on those substantially above the threshold; close to the threshold; and substantially below the threshold.

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what a sustained low-interest rate environment means for retirement income adequacy

Business

retirement incomewealth

retirement phase

retirement resources

adequate retirement

retirement readiness

entire retirement portfolio

defined benefit

percent of simulated