While the federal government has never defaulted, failure to lift the nation’s debt ceiling—a potential crisis now averted—could have had a significant impact not only financial markets, but a devastating impact on retirement savings.
Amid lingering fears that Congress would not act to lift the federal government’s debt ceiling limit, defaulting on its interest obligations and in the process potentially threatening the retirement savings of millions of Americans, after months of political maneuvering, lawmakers finally acted.
Following an earlier agreement by Senate leaders to allow a one-time exemption to the filibuster rules to allow a vote on raising the debt ceiling, the Senate on Dec. 14 and the House in the early morning hours of Dec. 15 approved S.J. Res 33 by votes of 50-49 and 221-209, respectively. The resolution, which is now cleared for President Biden’s signature, will lift the debt limit by $2.5 trillion to approximately $31.4 trillion.
Ripple Impact on Retirement Savings
A U.S. default might well have had far-reaching effects on financial markets, including a significant impact on long-term debt, creating a premium on liquidity, devaluation of capital, and increased risk in existing debt markets. In fact, estimates based on historical evidence suggest that the effect of a default could create losses in excess of 20% for all pension assets, according to a study prepared for the American Retirement Association by Judy Xanthopoulos, PhD.
At the end of March 2021, retirement savings totaled $35.4 trillion, with private retirement savings comprising the largest component of this total at nearly $25 trillion in employer-sponsored defined contribution plans and individual retirement arrangements.
Based on historical trends, immediate losses of private pension assets held in equities could have decreased by $1.95 trillion—or approximately 20% of private pension assets held in equities—if the U.S. were to fail to address the debt ceiling, the study warns.
During previous economic recessions, private pension assets lost approximately 30% in value, the study notes, citing an earlier report by the Urban Institute. During the 2011 debt ceiling negotiations, private pension assets declined an additional 26%. Additionally, based on previous experience during the 2008 financial crisis, estimates suggest that the effect of a default could decrease total pension assets by as much as $6.4 trillion, resulting from losses in the bond and other financial markets, or approximately 19.2% across all financial markets.
“It is important to recognize that these declines have long lasting effects on the future balances of retirement savings,” Xanthopoulos warns. “Specifically, the debt crisis lowers the balances, which dampens performance in all subsequent periods. Therefore, if the retirement balances decline substantially as a result of a debt crisis, then retirement saving in all future quarters will be permanently lower.”
Treasury Secretary Janet Yellen had previously warned that the federal government will reach the limit as soon as Dec. 15. This expansion of the limit should now push the issue off until 2023.
