Unless you plan to contract COVID-19 or otherwise court an early death, neither the pandemic nor anything short of the collapse of civilization will change the basics of retirement planning.
The strategy seeks to amass sufficient assets, including formal pensions and annuities, to throw off enough income to keep a person or a couple comfortable when the regular paycheck stops. This basic strategy remains unaltered. The post-Covid world will, however, alter the tactics needed to secure this perennial objective.
If today’s media is any guide, two issues take center stage in this matter. One is the supposed threat to the viability of Social Security, especially if President Trump gets his way and enacts payroll tax relief for low-income Americans. The fear is that financial inadequacies will render the system incapable or offering real benefits comparable to the past. The second has to do with the Federal Reserve’s (Fed’s) new policy framework and its implicit promise to keep interest rates lower for longer than would otherwise have occurred. The first of these concerns is bogus, though these days it serves political purposes. The second will make retirement planning more difficult and more risky.
On the proposed payroll tax relief, the White House is a long way from putting anything permanent enough in place to threaten the revenues of the Social Security trust fund. Those who suggest Trump’s executive order can do this are either ignorant of elementary civics or cynically fear mongering. The president lacks the power to order tax relief. That requires legislation passed by both houses of Congress. All his executive order does is allow lower-income wage earners and their employers to postpone payments of the tax until year end. The obligation to pay continues to accrue. Even if Trump were to win the election, hardly a sure thing, he would have a hard time getting the legislation through even a Republican Congress, which in any case is hardly likely.
Even if such legislation were to pass, it would hardly threaten payments to Social Security beneficiaries.
Washington has a number of ways to replenish any funds lost through this tax break. It could, for instance, raise the minimum retirement age. This kind of a move has been suggested many times in the past to accommodate the longer average life expectancies. Alternatively, the law could substitute for the revenues lost to this kind of tax relief by raising the maximum income subject to Social Security payroll taxes. Presently, the tax does not apply to any income above $137,700. Raising this figure to compensate for the break offered to lower-income Americans would certainly make the overall tax structure more progressive and has been suggested as a part of any proposed bill on this matter.
Even if Washington were to allow a revenue shortfall, it would not likely threaten levels of Social Security benefits. The system, unlike other pensions, is effectively integrated into the general federal budget. When Social Security revenues exceed outlays, the trust fund by law can only buy U.S. treasury bonds as an asset. In other words, any excess revenues go directly to the Treasury. If the trust fund has a shortfall, it can sell those treasury bonds, effectively drawing on the general resources of the federal government to meet its obligations. Even were the trust fund to exhaust its store of bonds, the obligation to pay beneficiaries would fall on the government generally. The trust fund is effectively an accounting fiction, since it secures a specific government obligation with a general government obligation.
If worries over Social Security benefits take a back seat in the general retirement planning equation, the Fed’s decision to keep interest rates lower for longer has great relevance.
In its old policy framework, the Fed would keep interest rates low until economic circumstances threatened to raise inflation rates above 2 percent, at which time policy makers would begin to raise interest rates gradually. Under the new framework, the Fed will keep rates low until inflation actually rises above 2 percent and even then tolerate greater rates of inflation for a while before it begins to raise interest rates.
Holding interest rates lower will impact retirement planning in the first place by rendering secure bonds as well as cash investments less useful than they once were in asset building. Since at the same time, low rates will improve prospects for equities and other risk assets, the new policy framework will make these more attractive in a retirement plan than they once were. But make no mistake: The change will impose greater risk on retirement plans. Planners will have to get used to this fact of life and accommodate greater levels of volatility than they once did.
The low interest rate environment will also make problems for the timing of asset shifts. Retirement plans typically use stocks and other risk assets to build wealth early in the plan’s life and gradually shift to more stable bonds as the retirement date approaches. This preference for secure bonds reflected their ability to throw off more income more reliably than stocks, making them until now the asset of choice during retirement years. Planners usually made the transition from stocks and other risk assets to secure bonds gradually over a period of years in order to avoid any need to sell equities during one of the market’s periodic dips. But now with lower rates on secure bonds hampering their ability to build wealth, planners will make the shift in their direction over a more compressed time frame than in the past, and in so doing raise the risk that asset sales will occur when stocks are suffering one of those downdrafts in prices.
And since a lower interest rate environment will mean that secure bonds will throw off less income in retirement, plans will need to use other, riskier and less stable assets to generate retirement income.
Junk bonds or high dividend-paying stocks may replace secure bonds as a way to produce that income. Foreign bonds may grow more popular, denominated in dollars or in other currencies. Retirement plans may also look to real estate investment trusts (REITs), which offer high percent dividends on a person’s investment but also come with considerable volatility and other risks. Annuities, once an effective way to gain considerable income from a relatively small investment, may lose favor. They have counted on secure bonds to generate the income they offer. As those bonds offer less, so will annuities, unless they, too, turn to these other sorts of assets with all their attendant risks.
No doubt the post-COVID world will impose other retirement planning considerations, as will secondary and tertiary reactions to that environment. For now these two matters are getting the most attention. The Social Security arguments are hardly worth the time, but the Fed’s response, as should be clear, will cause much upheaval in the way people and advisors approach the basic strategic aims of a retirement plan. It should also be apparent that no matter how they cut it, the plans and the people involved will have to get used to more volatility and more risk than heretofore.