Insights | Published in October 2016

What Is the ‘New Normal’?

How will a lower return environment impact retirement savings rates?

By Alison Cooke Mintzer | October 2016
PS-Portrait-Article-Insights.jpgWe consistently write about risks that plan sponsors must educate their participants about—longevity risk, market risk, sequence-of-returns risk—and how those risks are associated with delayed retirement or a lack of savings. When employees look at how their retirement savings could translate into retirement income, they have to make a number of assumptions about those risks in order to make a reasonable projection.

However, as of late, a number of analysts have predicted that the slower growth of the U.S. economy after the Great Recession could cause stock market returns to fall from 7%—the current annual average—to a possible 5% in the decades to come. Without even factoring in the potential implications for savings due to rising interest rates, those projections will undoubtedly have people rethinking how their savings will look as income.

The possibility of a “new normal” lower-return environment means people will have to defer more. A recent article on discussed a white paper that tried to quantify what percentage that would be. The paper suggested that longer lifespans coupled with future lower market return expectations would result in participants needing to save much more than the industry has been advising. In fact, this paper from NerdWallet suggested that, for Millennials, the savings rate would have to increase to about 22%.

How did the company reach that conclusion? NerdWallet analyzed the savings needs of a 25-year-old earning $40,000, the median average salary for ages 25 through 29, according to the U.S. Census Bureau’s 2015 Current Population Survey. Based on the 7% average in stock market returns each year since 1950, a 25-year-old earning $40,000 can meet a common retirement goal of replacing 80% of his income by age 67 by saving 13% of annual income. But if average annual stock market returns fall to 5%, NerdWallet’s analysis shows, a 25-year-old will have to set aside 22% of annual income to save the same amount. That’s an increase of $3,400 this year.

While that seems like a huge number, consider what it means for those not saving early! The paper’s analysis found that if a 25-year-old Millennial waits until age 35 to begin saving for retirement, he must save a nearly impossible 34% of income annually, or $16,400, to retire at age 67 with an 80% replacement income, assuming 5% annual returns. Anyone seeing that will likely say, “I can never retire.” Will they then just give up saving entirely?

For good reason, that article received some comments from our readers, who pointed out just how ridiculous it sounds to tell someone he has to set aside, at a minimum, more than 20% of his income for retirement. With all the competing priorities Millennials have, especially student loan debt, there just isn’t enough to go around.

Some complain that articles and papers like this are just fear-mongering by asset managers and recordkeepers to gather more assets and make more money. I’d argue instead that what is driving this is the idea that somehow people will work for 40 to 45 years and have to find a way to save enough to replace that income over what is apt to be the following 15 to 25 years, according to actuarial assumptions.

When is it time to really address the fact that, with today’s longevity, retirement at age 65 is just not viable? We talk about delayed retirement or working in retirement, but maybe retiring at 65 or 67 should be considered early retirement.

In this election year, once again, there is debate about what can be done with entitlement programs—but a discussion of retirement age isn’t just for Social Security and Medicare, and it is more than a reason for plan sponsors to get chief financial officers (CFOs) to understand the role of their company’s retirement plan.

The aging of our country and the longevity of our population means it’s time to think realistically about how people’s lives look after age 65 and realize that, yes, very few will have saved enough to retire at that age, and maybe that’s actually OK, as many people are just as capable at 65 as they had been in the decade prior.

I hate to bring up the origins of Social Security, but the reality is that when the social insurance program was implemented by Otto van Bismarck in Germany, it chose 70 as the age to collect, and people didn’t live much beyond that. Not to be morbid, but when was the last time you heard of someone dying at 70 and thought, well they lived a good life? Probably not recently, because now we consider that age relatively young.

The potential ageism or implicit bias of looking at 65 as being someone who is old, who can’t contribute and who should be planning to exit the work force soon should stop. If we realize that people are working productively longer and perhaps rethink our models to use longer working spans, it would remove some of the potential savings crisis we think we see and would allow us to show participants more reasonable savings rates, which would give them more hope that they could actually get there.