Most consumers and their advisors are aware of the havoc market volatility can have on a retirement income portfolio. Many seniors also fear outliving their retirement assets. But are they conscious of the devastating impact the prolonged low interest rate environment may have on their retirement savings?
A recent study by Prudential Financial and Ernst & Young calculated the impact of market volatility, longevity and sustained low interest rates on a hypothetical retirement portfolio of $300,000 in “Should Americans Be Insuring Their Retirement Income?”
Researchers ran that portfolio through three scenarios: one with no market volatility or longevity risk; another with both market volatility and longevity risk; and the third with market volatility, longevity risk and an extended period of low interest rates.
Using Ernst & Young’s Retirement Analytics™ model, which projected 2,000 “Monte Carlo” simulations of investment returns, interest rates and lifespans, researchers were able to get a percentage of how often the portfolio would run out of money, or the failure rate. In the second scenario, the portfolio ran out of income 21 percent of the time. In the third scenario, when low interest rates were factored in, the failure rate in the simulations rose to 54 percent.
“It almost doubles the probability of exhausting one’s assets when living in an environment of sustained low interest rates,” says Kimberly Supersano, chief marketing officer at Prudential Annuities.
To her knowledge, this is the first study to gauge the impact of protracted low interest rates on retirement income. “We’ve seen these statistics based on market volatility and longevity in the past,” she says. “This is the first time I’ve seen the overlay of the low interest rate impact. It’s a new phenomenon, and it doesn’t get a lot of visibility with the consumer. But it has a very significant impact on the ability to sustain retirement assets such a long time in retirement.”
Longevity is another significant risk that many Americans may be underestimating. “Most people don’t realize that they or their spouse could live in retirement for 20, 30 years or more,” Supersano says. “So much of the focus has been on accumulating retirement assets and not on how long those assets need to last.”
In a recent study by Prudential, 82 percent of respondents agreed that guaranteed investment products would be a “perfect addition” or “nice to have” for their retirement portfolio. Prudential has launched an educational effort to help advisors and their clients understand the usefulness of guaranteed retirement income products as they live longer, Supersano says.
“With the low interest rate environment it’s not as easy these days to get the yield on the safer investments that we once enjoyed years ago,” she says.
“It’s all about the amount of time,” she continues. “So it’s sequence of return [risk], but if you are going to lose some years when you are getting very low yield, that has a very significant impact on your overall retirement assets.”
One solution detailed in the study is a variable annuity with an optional lifetime income rider. Prudential specializes in variable annuities, a product class that has been rocked in recent months because of the low interest rate environment. Nevertheless, Supersano maintains the demand for the product remains strong.
“Certainly, the industry has been affected by the low interest rates and the market volatility,” she says. “I don’t see the changes in the industry as a negative necessarily. It’s a reflection of being mindful and thoughtful of the headwinds the markets present to us but recognizing that we need to be sustainable because the need continues to be so great and will only continue to grow.”