Low Returns and Optimal Retirement Savings

Abstract

Lifetime financial outcomes relate closely to the sequence of investment returns earned over the lifecycle. Higher return assumptions allow individuals to save at a lower rate, withdraw at a higher rate, retire with a lower wealth accumulation, and enjoy a higher standard of living throughout their lifetimes. Often analysis of this topic is based on the investment performance found in historical market returns. However, at the present bond yields are historically lower and equity prices are quite high, suggesting that individuals will likely experience lower returns in the future. Increases in life expectancy, especially among higher-income workers who must also rely more heavily on their private savings to smooth spending, further increases the cost of funding retirement income today. The implications are higher savings rates, lower withdrawal rates, the need for a larger nest egg at retirement, and a lower lifetime standard of living. We demonstrate this using a basic life cycle framework, and provide a more complex analysis of optimal savings rates that incorporates Social Security, tax rates before and after retirement, actual retirement spending patterns, and differences in expected longevity by income. We find that lower-income workers will need to save about 50 percent more if low rates of return persist in the future, and higher-income workers will need to save nearly twice as much in a low return environment compared to the optimal savings using historical returns.Links to third party websites are provided by Oxford in good faith and for information only. Oxford disclaims any responsibility for the materials contained in any third party website referenced in this work.

Save more with less: The impact of employer defaults and match rates on retirement saving

“…A more sophisticated participant may believe that they can identify a more optimal savings rate than the default—especially if it is set far lower than the optimal life cycle rate. Optimal life‐cycle savings rates rise with income, increasing the potential gap between the default and the optimal savings rates among higher‐income workers and motivating greater attention to increase savings rates (Blanchett et al, 2017). Higher‐income, more financially sophisticated participants may also be motivated to increase their savings rate because they recognize the benefit of enhanced returns through an employer match.…”