Market volatility raises the bar for how much you will need to save for retirement

In the wake of the United Kingdom’s decision to exit the European Union, global market volatility has not only sent investment portfolios on a roller coaster ride, it has also raised the prospective cost of income for near-retirees.

Pre-retirees now need nearly 10% more in retirement savings than before the Brexit vote in order to generate the same level of income, according to BlackRock, a provider of investment and advisory services for institutional and retail clients.

Since the historic vote on June 23, BlackRock’s CoRI Retirement Indexes have spiked nearly 10%. The indexes help investors estimate how much annual retirement income their current savings will generate for life starting at age 65. When interest rates fall, the cost of buying an immediate annuity to generate future income rises.

A 55-year-old would need $17.64 saved today to generate each dollar of annual retirement income starting at age 65, according to the CoRI tool. Based on that estimate, a 55-year-old with a $500,000 nest egg could expect $28,435 in annual retirement income initially, adjusted for future inflation.

Interest rates also play a crucial role in the health of the Social Security trust funds.

The Social Security and Medicare Trustees Report for 2016, which was released the day before the historic Brexit vote, sparked little interest this year. Most of the media coverage focused on the ho-hum fact that the hypothetical Old Age, Survivor and Disability Trust Fund will be depleted in 2034, the same year projected in last year’s report. After that, there would only be sufficient revenue from earmarked payroll taxes to pay about 77% of promised retirement and survivor benefits — unless Congress approves needed changes before then.

I spent the past weekend sifting through hundreds of pages of charts and analyses that make up the trustees’ report. It contains some fascinating insights regarding birth rates, mortality rates and immigration trends, as well as a variety of economic forecasts pertaining to productivity, inflation and interest rates that all factor into the future health of the Social Security system.

Here’s one interesting factoid: Social Security’s total income will continue to exceed benefit payments through 2019. Income consists of payroll tax revenue, taxes paid on Social Security benefits and interest earned on the trust fund surplus. The 2015 surplus of total income relative to cost was $23 billion.

But if interest income of more than $91 billion is excluded, Social Security’s costs would have exceeded non-interest income last year, as it has done every year since 2010. Because of the Great Recession, unemployment spiked and payroll tax collections declined. Many older workers were forced into early retirement, increasing benefit payouts.

Federal law requires that all excess funds be invested in interest-bearing securities backed by the full faith and credit of the United States. The Department of Treasury currently invests all program revenues in special non-marketable securities of the U.S. government.

That means that interest earned on the Social Security trust fund assets is the only thing preventing the system from being in the red right now. The trustees project that this annual non-interest deficit will average about $69 billion between 2016 and 2019.

After 2019, interest income and redemption of trust fund assets reserves from the General Fund of the Treasury will provide the resources needed to offset Social Security’s annual deficits until 2034 which is when the reserve will be depleted.

Just imagine how much larger that financial cushion would be if annual real interest rates on trust fund assets were closer to the 3.15% average of the past 40 years rather than the 0.83% experienced in the 2007-2014 period.

Alas, rates are unlikely to return to historical averages in the near future. “With slow economic growth, potential financial instability abroad and little prospect of high inflation, real interest rates have continued to remain low,” the trustees’ report said. Thus, they lowered the real interest rate assumption by 0.2 percentage points from last year’s report to an average of 2.7% through the 75-year projection period ending in 2090.

“Both Social Security and Medicare will experience cost growth substantially in excess of GDP growth through the mid-2030s due to rapid population aging caused by the large baby boom generation entering retirement and lower-birth-rate generations entering employment,” the trustees wrote.

They urged Congress to “take action sooner rather than later to address these shortfalls so that a broader range of solutions can be considered and more time will be available to phase in changes while giving the public adequate time to prepare.” Perhaps the next president will make this issue a priority.

(Questions about new Social Security rules? Find the answers in my new ebook.)
Mary Beth Franklin is a certified financial planner.