How will the sustained period of low interest rates affect retirement planning?

A forthcoming study from the Employee Benefit Research Institute attempts to quantify the very real effect that low interest rates and muted yields in certain asset classes could have on investors’ ability to sock away enough to cover their retirement.

“This low-interest environment has an extremely large impact on failure rates,” EBRI research director Jack VanDerhei said at a policy forum event previewing the research.

In a scenario where retirement income and wealth account for 100% of an investor’s simulated retirement expenses, VanDerhei’s model projects that around a quarter of baby boomers and Gen Xers who would have had sufficient retirement income under interest rates at historical averages would run out of money if the current low rates were taken as a permanent condition.

VanDerhei acknowledges that that is a hypothetical -- and improbable situation -- and that the impact of low rates on an investor’s retirement picture would be mitigated by other types of holdings. For instance, only 5% to 8% of the same boomers and Xers would run out of money under perpetually low rates if income and wealth accounted for 80% or less of their retirement expenses, according to the EBRI model.

Further, VanDerhei noted that the effects of low interest rates are felt most dramatically among the top three quartiles of investors, with the less affluent more shielded from the effect of interest rates on bonds and other asset types with similar characteristics.

The upshot of EBRI's forthcoming study is a new metric VanderHei calls the Retirement Readiness Rating, which models the percentage of “simulated life-paths” that will not run short of money throughout retirement.

VanDerhei does not argue that historically low interest rates will torpedo investors' retirement savings, particularly given the safety net in place in the form of Social Security. Still, he warns that failing to account for low rates (along with other factors) could make for a more spare retirement.

"Given the impact of Social Security, most households are never going to run out of money," he said. "But they certainly could run short."

VanDerhei told Financial Planning that the EBRI report is expected to be finalized and publicly available within the next month.

Kenneth Corbin writes Financial Planning, a SourceMedia publication.

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