Inflation-adjusted interest rates, driven well below zero by the pandemic and the Federal Reserve's response to it, have been at historically low levels for most of the past decade.
While economists debate the reasons for persistently low interest rates, the phenomenon raises a practical question for many people: How does it affect my plans for retirement?
Our research suggests that people can respond to persistently low interest rates by delaying Social Security and changing the way they save for retirement. And, particularly once the health risks associated with the pandemic have passed, many older individuals may find it worthwhile to work longer.
First, low interest rates make it more attractive to delay claiming Social Security, which can be obtained at any age between 62 and 70.
Delaying Social Security involves a trade off: Starting later means losing out on benefits now but receiving higher monthly benefits in the future. Our research shows that, when interest rates are near zero, delaying benefits is a good deal for most people.
That's because each year of Social Security delay results in roughly 8% higher monthly benefits in the future. And that's a guaranteed, inflation-adjusted return –something not available in a 401(k) or IRA when interest rates are low.
Delaying Social Security is a particularly good deal for married primary earners, who can pass on their higher benefit to their spouse, but some degree of delay probably makes sense even for single people and secondary earners.
While some may be concerned about not living long enough to collect the higher monthly benefit, our calculations suggest that even after taking this into account, for most people, the expected return from delaying Social Security is still higher than the return on comparably safe investments.
Second, zero or low inflation-adjusted interest rates may make it more attractive to work longer, especially for those who do not have retirement resources – like 401(k)s and IRAs – that they can tap into while delaying Social Security.
Working longer also allows for additional retirement contributions (possibly including employer contributions) and reduces the number of years over which retirement savings must be stretched.
Third, our research suggests that low interest rates should prompt a reevaluation of retirement spending goals. Conventional financial planning suggests that retirement planning should be based on a target replacement rate, or a percentage of pre-retirement income that one wishes to spend during retirement.