The Impact of Interest Rates on the National Retirement Risk Index

The National Retirement Risk Index (NRRI) measures the share of working-age households who are “at risk” of being unable to maintain their pre-retirement standard of living in retirement. The Index is calculated by comparing households’ projected replacement rates – retirement income as a percent of pre-retirement income – with target rates that would allow them to maintain their living standard. The Index is the percent of households for which the projection falls short of the target. The NRRI is based on the Federal Reserve’s Survey of Consumer Finances (SCF). The SCF is a triennial survey of a nationally representative sample of U.S. households, which collects detailed information on households’ assets, liabilities, and demographic characteristics. The NRRI results show that, even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, more than half of households are at risk. Real – inflation-adjusted – interest rates enter into the NRRI calculation primarily through the assumption that households purchase an inflation-indexed annuity with their assets at retirement. These assets include 401(k)/IRA holdings, financial assets outside of tax-preferred plans, and the proceeds from accessing home equity through a reverse mortgage. The higher the interest rate, the more income these financial assets produce. This effect is partially reduced by the fact that the portion of the house that can be accessed through a reverse mortgage varies inversely with the nominal interest rate. Interest rates do not play a role during the asset accumulation period, because, as described below, assets at 65 are based on the steady relationship by age between wealth and income reported in the SCF. This brief explores the percent of households at risk under two alternative interest rate scenarios: 1) real rates remain at zero as currently suggested by the yield on 10-year Treasury Inflation-Protected Securities (TIPS); or 2) real rates revert to the 4-percent level experienced when the indexed securities were first introduced in the 1990s. The discussion proceeds as follows. The first section describes the nuts and bolts of constructing the NRRI. The second section discusses the role of interest rates in the NRRI and reports the results. The final section concludes that changing interest rates has only a modest effect on the NRRI, and that, regardless of the interest rate, today’s workers face a major retirement income challenge.