Saving For Retirement Just Got Harder In A Sour Fall 2020 Economy

Economy Is Looking Bad

With the prospects of a stimulus package souring (see the tussle between Sherrod Brown and Steven Munchin yesterday), the major banks JP Morgan and Goldman Sachs predicting a slower economy in Fall 2020, a potential spike in COVID-19 cases this Fall, and what Gillian Tett in the Financial Times warns about the growing threat of bank defaults across the globe, the recession that started in February 2020 is looking more likely to linger.

Unemployment claims ticked up yesterday, September 24, over 20 million people are jobless, evictions are looming, and more Americans are concerned about not being able to pay bills.

And even though the average American household is accumulating cash, on average savings rates are sky high, over 17% in July,  there are no signs any of this income is going toward retirement savings. Altogether this means savings, and saving for retirement, is now a much lower priority.  

Retirement Savings In The Tank

In fact, there are plenty of signs the typical American is worse off in terms of retirement savings. Low retirement plan coverage at work will not get better, especially as employers respond to the recession by stopping and planning to stop contributions to their employees’ 401(k) plans, while their workers’ bargaining power is low.

And lower interest rates and returns mean any American saving for retirement will have to save more.  The few employers that make their employees’ retirement security a priority will also have to save more. The way University of Pennsylvania Professor Olivia Mitchell puts it in an excellent paper written this year, employers and workers will have to “rethink” plan contribution rates. But “rethinking” may be dramatic, many employers and employees are giving up saving for retirement in any substantial way. The cold, hard math of saving for retirement in a low return environment seems to make the whole enterprise a bit hopeless.

If real returns remain low for years, individual saving rates for retirement will have to soar. MIT Professor James Poterba predicts that contribution rates should be 33-48% of earnings to pay for a lifetime income stream, covering half of workers’ pre-retirement income (assuming a 4% investment return, a 2% inflation rate, and saving for 20 years). If workers save for retirement over a 30-year contribution period, the required saving rate lowers as people have more time to save. The required savings rate for a 30-year period is 15-16% of pay.

But the thing is, returns on investment savings may be much lower than 4% and saving rates must rise even higher — to perhaps 50% of pay — if the goal is to generate a payout stream that (more or less) keeps pace with inflation.

Saving half of one’s pay for 20 years is simply ridiculous, no financial advisor or financial literacy can solve the reality that advanced saving for retirement has become almost impossible.

To worsen matters, it seems people are giving up retirement savings, at least for a while. According to a new survey from Schwab Retirement Plan Services, of an admittedly elite group of workers — those who are currently employed and participate in a 401(k) plan — anxiety is way up when it comes to long-term retirement savings. Only 38% of this group feels confident they have enough to retire on and far fewer women are confident they will have enough.  

Additionally, a Spring  survey by Magnify Money and Lendingtree

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shows 30% of Americans have withdrawn money from their retirement savings accounts in the last two months for groceries and housing bills. I am not going to criticize people for dipping into their retirement funds for emergency savings and groceries in this recession, even if the costs in the future will be quite high, as people give up tax free accumulations.

Do We Cancel Retirement?

Boston College economists, Joseph Quinn and Kevin E. Cahill have done some “rethinking” about the practicality of saving for retirement in a period of low interest rates. Low rates hit retirement from two sides. Low interest rates induce people to take on more debt, and at the same time low rates reduce the effectiveness of retirement saving. The share of individuals aged 65 and older with debt increased from 30 percent to 43 percent, from 1998 to 2010, while the average leverage ratio — total household debt divided by total household assets — doubled.

Quinn and Cahill speak for many economists when they point to a particular solution to the retirement income security crises: partially cancel retirement. They see a silver lining to people having fewer retirement years, they write that not only can working more make up for inadequate pensions, but also employers will be better off (employers always like more people seeking work – increased labor supply reduces wages), and also society would have more goods and services (cancelling the weekends and holidays would have the similar effects).

But working longer seems extreme and harsh in many cases. First, the COVID-19 recession makes working longer disjointed from reality. Older workers face difficulties keeping and finding a job. Second, Americans already have fewer expected retirement years than almost all workers in rich countries. Third, retirees, even if they are physically able to work, overwhelming enjoy not working and having time for themselves before they die.

Another option is to rethink how we deliver old age security, without forcing Americans to give up dignified retirement years, or the freedom to structure their physical, productive, and social activities before infirmity and death.