Retirees took another wallop from COVID-19 with the Federal
Reserve’s announcement two weeks ago that it expects to hold interest rates
near zero at least until 2023 because of the pandemic. That spells lower
returns for retirement accounts, and it adds to the underfunding of pensions
that has worried retirees for many years now.
The implications of lower returns on investments are that
retirees may save less, dip into their retirement savings, and start collecting
Social Security benefits earlier than planned, according to Olivia S. Mitchell,
Wharton professor of business economics and public policy and executive
director of the School’s Pension Research Council.
“Low returns from the market are essentially a tax on
retirees,” Mitchell said in a recent episode of the Wharton Business Daily show
on SiriusXM. (Listen to the podcast above.)
“In the good old days, people used to ladder their bonds,
put a little bit of money in the market, and try to live off those returns,”
Mitchell noted. (A bond ladder refers to investments in bonds with varying
maturities so that a portfolio does not get locked into one type of bond.)
“This is not feasible any longer. In fact, it’s even worse, because those lower
nominal returns are in many cases negative in real, or inflation-corrected,
returns.”
Retirees may respond to the prospect of low returns by
saving less, Mitchell said: “If you’re not rewarded for deferring your
consumption as much, then why do it?” Their savings would fall especially in
tax-qualified retirement plans, she predicted. The tax-qualified feature is
helpful for those who aim to build an asset base over time with interest and
other returns on their investments, while they are in relatively lower tax
brackets. But now, “those build-ups are simply not happening the way that
people had planned,” she said. “If people do save, they’ll probably save less
overall, and they will tend to save in other non-tax favored accounts like bank
saving and checking accounts, where you’re lucky if you’re earning half a
percentage point.”
Desperate Times
Mitchell recalled that the 2008–2009 global financial crisis
was “a bath of cold water for retirees, savers, pension funds, insurance
companies, and so on.” However, back then, an economic recovery followed, and
“the labor market didn’t suffer as badly as it has during the COVID-19
pandemic, and for as long as it has,” she noted. Nowadays, people’s
perspectives on retirement have changed and they are looking to work a little
longer. “But the question is, can you even find a job, especially if you are an
older worker?” she asked.
In times of desperation, some people may claim their Social
Security benefits sooner than they may have planned — despite the fact that
every year of delay could boost their eventual benefit by 7% to 8%, Mitchell said.
“People who don’t have any retirement savings may have to go ahead and claim
their [Social Security] benefits early, thereby experiencing a lower payout the
rest of their lives.”
Others that have lost jobs have drawn down some of their
401(k) savings. Since April, they have been living off the government’s
“economic impact payment” of $1,200 per individual (an additional $500 for each
child), and the expanded unemployment insurance benefits contained in the $2.2
trillion CARES Act. “Those have now tapered off, and Congress has not yet been
able to come in with a new COVID financing bill,” Mitchell stated. Some people
might consider options like starting their own small business, but “this is a
pretty tough environment in which to start a new business,” she added.
The 2020 CARES Act permitted individuals to make early
withdrawals up to $100,000 from 401(k) and 403(b) accounts without penalties.
That hasn’t caught on so far because the economic stimulus payments provided
money to cope with the pandemic in the short term. However, it may not be
possible to stave off early withdrawals from retirement accounts for too long,
said Mitchell.
“Going into the fall and winter, I do worry that [early
withdrawals from retirement accounts] will become more of an option if the labor
market doesn’t recover,” Mitchell said. “And so, people might end up biting off
their nose to spite their face. Yes, they’ll get some cash, but what does it
say about their retirement? Not much [that is] good.”
“The first and most important thing that needs to be done by
policymakers is to bring Social Security back into solvency.”
A Perfect Storm
Also looming is the possibility that the Social Security
Trust Fund could run out of money by 2029, rather than 2032 or 2034 as had been
predicted by the Penn Wharton Budget Model after the pandemic struck. This
could happen “since people aren’t paying the payroll taxes needed to keep the
system afloat and potentially because people are claiming [their benefits]
earlier,” said Mitchell. “The first and most important thing that needs to be
done by policymakers is bring Social Security back into solvency.”
For sure, pension funds and insurance companies have also
been suffering from low returns, Mitchell continued. “Many of the state and
municipal pension plans are probably not going to make it through this COVID
crisis with any healthy amount of funding.”
As it happens, pension plans are facing “a perfect storm”
now, said Mitchell. They faced the 2008–2009 financial crisis without being
fully funded, but in later years “continued to invest in risky assets, hoping
to make it up in the great capital market lottery.” During the pandemic, many
pension funds lost 30% to 40% of their value, and the forecasted low returns
will make it “very difficult for them to survive,” she added.
In that seemingly hopeless situation, Mitchell saw annuities
as a “potentially appealing” option for retirement planning. Annuities are
insurance products that pay an income in retirement. Even if the insurance
investments held by annuity providers don’t make much money, investors who
outlive others in their pool will be eligible for survival credits (also known
as mortality credits), she noted. She suggested that it is a good idea for
employers and retirement plan sponsors to include annuities in 401(k) and
403(b) accounts, now permitted by the Secure Act since late 2019.
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