Two years after the near-meltdown of the global credit system — and even while our economic recovery gains momentum — the Federal Reserve still feels compelled to keep its interest rates at virtually zero. However strong the arguments for continuing low rates until the recovery becomes fully self-sustaining, there is no doubt that this policy has unfairly inflicted real harm on prudent retirees, who depend on interest earnings to meet their life expenses. This is wrong.
If this Fed policy continues, Congress should grant savers over 65 some countercyclical tax relief on their earnings from bank deposits, bonds, bond funds and money market instruments. We could, for example, drop all federal income taxes on the first $10,000 of retirees' interest income for any tax year in which the federal funds rate averages below 2%.
SPEED A TRANSITION
Short-term, this could help spur the recovery by raising millions of retirees' after-tax income and spending power. More importantly, encouraging savings and rewarding prudence would help speed a transition that America absolutely needs — to higher savings rates, increased private-capital investment and rising productivity.
That is the only tolerable way that our country can ever “outgrow” our mountainous national debt.
Instead of fostering pro-savings behavior, ultralow interest rates inflict a perverse — and unjust — penalty on thrift and prudence. Those hurt most by a zero-interest-rate policy are people who have worked for decades, saved regularly and deferred gratification, only to see their retirement dreams derailed by artificially low rates imposed on their savings when they are no longer working.
In this recession-cum-recovery cycle, prudent investors who downshifted their risk profiles were effectively penalized by central-bank policies designed at least in part to rescue imprudent risk takers and the banks who lent them money.
Those hurt worst were those who followed conventional wisdom most faithfully. Nearly all financial advisers tell their clients to lower their relative share of highly volatile assets, such as stocks, and increase their holdings of more stable, fixed-income assets as they age.
Ironically, this seemingly prudent path makes senior savers far more vulnerable than young savers to major downdrafts in Federal Reserve interest rate policy.
An average 65-year-old, for example, typically would be advised to allocate 50% or more of his or her retirement assets to fixed-income instruments or “cash” — in the form of bank certificates of deposit, money market funds, municipal bonds, Treasury bonds and bills, and corporate bonds. Eighty-year-olds might well be advised to hold even higher allocations of fixed income, as much as 75% or more.
And over the half century since 1960, such fixed-income assets have, in fact, delivered substantial returns.
From the 1970s through the 1990s, for example, even the three least risky fixed-income categories — Treasury bills, money funds and bank CDs — never yielded less than 3.37%. So far this year, all three categories have offered returns measured in basis points — just a few hundredths of 1%.
Further out the curve, and as recently as 2007, a conservative senior investing $100,000 in 10-year Treasury bonds could realize after-tax income of $3,473 if he or she was, for example, in the 25% bracket. The same prudent retiree who commits $100,000 to 10-year Treasury bonds today can expect annual after-tax income of just $2,408 if they are in the 25% tax bracket.
That is an income loss of nearly 31% in less than three years.
What exactly do Fed policymakers suggest that cautious seniors do? Ramp up their exposure to equities? Embrace risk? Live dangerously?
This has to change.
Let's stop hurting people who have saved for decades and invested cautiously — those who played by the rules, helped finance our country's growth and followed mainstream financial advice. Granting seniors some relief on interest income is way overdue.
Should the Fed stay on a low-interest-rate course, Congress can act to remedy this injustice. It is only fair.
Lenny Glynn is managing director for policy at Putnam Investments.