How Persistent Low Expected Returns Alter Optimal Life Cycle Saving, Investment, and Retirement Behavior

Abstract

This paper explores how a capital market environment of persistent low returns influences saving, investing, and retirement decisions and behaviors, as compared to what in the past had been thought of as more "normal" financial conditions. Our calibrated lifecycle dynamic model with realistic tax, minimum distribution, as well as uncertain income, stock returns, and mortality and Social Security benefit rules produces results that agree with observed work, and claiming age behavior of U.S. households.During the work life, the individual we consider has the opportunity to use current cash on hand for consumption and investments. Some portion of the worker's pre-tax salary (up to a limit of $18K) can be invested into a tax-qualified 401(k)-retirement plan of the EET type. That is, contributions into the account and investment earnings on account assets are tax-exempt, while withdrawals are taxed. In addition, a worker can invest outside his retirement plan in risky stocks and riskless bonds. The individual pays taxes (labor income tax, Medicare, City and State Tax, Social Security tax). Our model allows for flexible work effort and retirement ages. The worker can retire and claim Social Security benefits between age 62 and 70.The parameter of our model are matched, so that the model generates a large peak at the earliest claiming age at 62, as we can see in the data. Also in line with the empirical evidence, our baseline results show a smaller second peak at the (system-defined) Full Retirement Age of 66. Key Findings:The results of alternative interest rate regimes are also quite informative.• First, One sensible result is that people are predicted to save less during periods of low returns.• Second, people tend to finance consumption relatively early in retirement by drawing down their 401(k) assets sooner.• Third, low rates also change in which locations people save. During low-return periods, workers save less in tax-qualified accounts and more outside tax-qualified plans, until retirement. The reason is that the tax advantages of saving in 401(k) plans are relatively less attractive, inasmuch as the gain from saving in pretax plans is lower, and because the return on assets in the retirement account are lower in a low return environment.• And fourth, we find that low interest rates drive workers to claim Social Security benefits later, so they can take advantage of the relatively high payoff to deferring retirement under current rules. In this way we confirm that Social Security claiming rules have a powerful effect on how households are able to adjust to financial market fluctuations.Electronic copy available at: https://ssrn.com/abstract=3076397 AbstractThis Chapter explores how an environment of persistent low returns influences saving, investing, and retirement behaviors, as compared to what in the past had been thought of as more "normal" financial conditions. Our calibrated lifecycle dynamic model with realistic tax, minimum distribution, and Social Security benefit rules produces results that agree wi...

The impact of post‐retirement financial market participation on retirement income sufficiency in Australia

“…Boyle Torrey and Teauber (1986) have also shown that other post‐retirement incomes, for example, rent from investment properties and interest incomes from passive investments such as bonds, are also significantly reduced in a low‐interest rate environment. Horneff et al (2018) show that Americans are predicted to save less and tend to draw down their 401(k) earlier to finance their consumption during periods of low interest rates, which subsequently puts more pressure on retirees, especially due to longer life expectancies.…”