Among the Americans who are growing panicky about a potential government default are Wall Street traders, who recently sent a letter to Treasury Secretary Janet Yellen warning of the “costly” and “long-term” implications of a default and the “seismic” consequences of such an event.
Those warnings should ring an alarm bell for retirement savers because of the impact a default would have on the financial markets — and their retirement accounts.
Because so much retirement money in the United States is tied up in 401(k)s, individual retirement accounts and other accounts that depend on a healthy stock market to grow, a default could cause their savings to tumble in a hurry. Look no further than the 2008 financial crisis, when retirement accounts lost 32% of their value (about $2.8 trillion) as of Dec. 2 of that year, according to an analysis from the Urban Institute.
Yellen recently told Congress that the U.S. could default on its debt as early as June 1. Although lawmakers have been meeting to discuss ways to raise the debt ceiling before that date, no agreement has been reached so far.
If the government does go into default, here are five ways it could impact your retirement savings.
Stock Market Crash
On May 3, the White House issued a notice assessing the potential impact of a government default. It cited a Council of Economic Advisors (CEA) analysis estimating that in the 2023 third quarter — the first full quarter of the simulated debt ceiling breach — the stock market would plummet 45%, leading to a “hit to retirement accounts.”
Meanwhile, a late 2022 report from the Third Way think tank projected that a typical worker nearing retirement with 401(k) savings could lose $20,000 if the U.S. were to default on its debt, NPR reported.
“The best way for investors to achieve their own success is by focusing on the things that they can control: saving regularly, keeping costs and taxes from eating away at your nest egg and knowing what you need to meet your goal,” Joel Dickson, Vanguard’s global head of advice methodology, told NPR. “Sticking to that plan and controlling what you can is the best way for success.”
Reduced Income
A default would hit both the economy and the financial markets, which would impact both earnings and investment income. Many employers would likely have to freeze raises and bonuses or even implement pay cuts. This would reduce the amount of money available for retirement savings, while declining stock valuations would reduce those savings even further.
“That’s where we talk about the importance [of] preparing for the unexpected,” Dickson said. “Think about things like having rainy day funds or backup plans.”
Delayed Paychecks
This would mainly come in the form of paychecks to federal employees. More than 2 million federal civilian workers and about 1.4 million active-duty military members could see their paychecks delayed in the event of a default, CNN reported.
For these people, delayed paychecks could affect both government pension savings and additional money available for retirement savings. Federal government contractors could also see a delay in payments, CNN noted, which would affect their ability to pay their own workers.
Higher Unemployment
The CEA projected that a default would cause unemployment to increase by five percentage points as consumers spend less and businesses lay off workers. Workers who lose their jobs would also lose their ability to contribute to retirement savings.
As the White House noted, a recession caused by a default means the government would not be able to provide the kind of financial relief it delivered during the Great Recession and COVID-19 pandemic.
“As the breach continues, the economy heals slowly, and unemployment is still 3 percentage points higher at the end of 2023,” the White House memo stated.
Even if the default only lasts for about a week, close to 1 million jobs would be lost, CNN reported, citing data from Moody’s. If it went on for six weeks, more than 7 million jobs would be lost and the unemployment rate would soar above 8%.
Higher Borrowing Costs
A default would likely cause an increase in U.S. Treasury yields, CNN reported, which in turn would lead to higher interest rates on loans, credit cards and mortgages. Paying more money on loans and revolving credit means less money is available for retirement savings.