If retirement is approaching (regardless of your personal definition of retirement), it’s understandable that you’ll worry about the risks you’ll face. But maybe you worry too much about the Wrong those.
This is the conclusion of economist Wenliang Hou and the basis of a recent article he wrote for the Retirement Research Center (CRR) at Boston College,”To what extent do retirees assess the risks they face in retirement?(Hou came up with his findings while working there; these days, he’s a quantitative analyst in the fixed income division of Fidelity Investments.)
The 5 big risks of retirement
Basically, says Hou, there are five major risks in retirement:
· Longevity risk — the risk that you will outlive your money
· Market risk — the risk of stock market and real estate market volatility
· Health risk — the risk of unexpected medical expenses and long-term care needs
· Family risk — the risk of things like divorce, the death of a spouse or partner, and adult children becoming ill or unemployed
· Political risk — the risk of insolvency of social security funds, leading to a 20-25% reduction in pension benefits in the absence of a change in policy
Hou compared everyone’s actual risks (called objective or empirical risks) with how people assess the likelihood of those risks (called subjective risks). To do this, he looked at the University of Michigan’s biennial Health and Retirement Study, which surveys about 20,000 people over the age of 50, and then looked at the data.
What he found: “People underestimate their longevity and they overestimate market volatility,” Hou told me.
What people fear most compared to reality
Specifically, Hou ranked the public’s view of his retirement risks in this order: market risk, longevity risk, health risk, family risk, and political risk. But their real retirement risks, he found, are in this order: longevity risk, health risk, market risk, family risk and political risk.
“Longevity is the biggest risk because people have to spread their resources over the retirement horizon to make decisions,” Hou says.
People who are unrealistic about their lifespan may therefore not save as much as they need or spend more in retirement than is wise.
Plus, says Hou, “they can make bad decisions about when they stop working and start claiming Social Security benefits.”
Leaving work for full-time retirement can mean no longer saving for retirement in a 401(k). Claiming Social Security at, say, 62 will reduce the amount of your retirement benefit compared to waiting until your mid to late 60s. You get 8% more from Social Security for each year you delay applying between your full retirement age (usually between 66 and 67) and 70.
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The longevity gaffe we make
Americans often predict their longevity based on their parents’ age at death, which can be in their 60s, Hou says. But we generally live longer than our parents.
Actual mortality statistics indicate that today’s 65-year-old man in the United States can expect to live, on average, to be about 87; a 65-year-old woman to about 89.
Life expectancy for both men and women has jumped more than 10% since 2000, according to the Society of Actuaries, notes author Mark Miller in his excellent forthcoming book, Retirement Reboot: Commonsense Strategies for Getting Back on Track. “.
Averages being averages, you may live to be 90 or 100 – or not. Of course, it is impossible to know exactly how long you will live. Your genes play a role. The same goes for your current health, your future health, your medical history, the possibility of an accident or being the victim of a crime and simply the unexpected.
I’m 66 and the rudimentary (and, okay, a bit morbid) Actuary Longevity Calculator calculate that I have a 71% chance of living to 80, a 55% chance of living to 85, and a 31% chance of living to 90. I take these numbers into account in my retirement planning.
Market risk: real, but not as bad as you think
Regarding market risk, Hou wrote that “individuals on average have very pessimistic and larger volatility expectations than the empirical evidence suggests.” In fact, their expectations for market volatility are almost double what the data shows.
Here’s the problem: “If you feel like you’re going to lose a lot of money, you stop investing. And that’s not ideal,” Hou says. “Should we stop investing with a long-term perspective? I would probably say “No”.
I understand why so many people are so nervous about stock market volatility eroding their retirement savings. Ho too. “People are exposed to daily news headlines [about market volatility] and that’s something they keep in mind,” he acknowledges.
But, Hou says, by living longer, you also end up reducing the negative effect of a year’s stock market volatility on your retirement.
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How a stable lifetime income can help
Since longevity and market risks are the No. 1 and 2 risks for retirement, he says: “it is better to have stable resources for life” to cover them.
This could mean buying an annuity with part of your savings (a product from an insurance company providing a fixed monthly income). Or it could mean converting some of your 401(k) into an annuity in retirement, which was made easier by the Federal SECURE Act of 2019. The insurance industry sometimes calls annuities “protected income”.
As Jean Statler, managing director of the Alliance for Lifetime Income – the educational group for the annuity insurance industry – told me, “There is a stable income you can get in retirement that is guaranteed and protects you from volatile market ups and downs. The answer to risk is certainty, and annuities provide certainty.
But few people buy immediate retirement annuities – ones that start generating monthly income shortly after purchase.
In a 2021 CRR article, Hou and two colleagues wrote that “the U.S. payout annuity market is tiny.” Their sales in 2018 totaled $9.7 billion while spending on long-term care was around $150 billion, they noted. The authors stated that some people avoid annuities because the products are expensive; some do not like the idea of entrusting control of their life savings to insurers.
Statler says his group’s research shows a third of finance professionals are now more likely to recommend an annuity for retirement due to the current climate of rising interest rates, inflation and anxiety about market volatility.
But, Alliance communications director Cyrus Bamji adds, “There is a huge gap between what clients ask for and are looking for – which is a type of safe income – and what advisors think They want. This is one of the gaps that we are trying to fill.
Social Security also provides a stable income for life, effectively in the form of a monthly pension.
“I would say Social Security is the best option for annuity income for retirement,” Hou notes. “And if people can delay applying for Social Security to accommodate their actual risk, that will be better.”
Monthly benefits for people who delay applying for Social Security until age 70 (which few can afford) are at least 76% higher than those claimed at age 62.
Planning for health risks in retirement
Health risks in retirement, or more specifically health care costs in retirement, are essential to consider and plan for. But they’re also often underestimated, says Hou. In his research, he notes, “you can really see the big gap for end-of-life medical expenses” between what people expect to pay and what they actually pay.
According to Fidelity Investments’ annual projections, an average 65-year-old retired couple may need about $315,000 to cover health care expenses in retirement.
And that doesn’t include the possibility of long-term care costs, which can be exorbitant. The median cost of a private room in a nursing home in 2022 is $108,405, according to Genworth Cost of Care Study. In assisted living, it’s $54,000. A home helper manages $61,776.
As Hou wrote, “Long-term care is a big risk for retirees, but they often underestimate it.” Better-designed public programs and private products could help protect retirees with limited financial resources from this potentially catastrophic risk, he added.
What are you worried about?
I would like to know: What are the risks associated with retirement? you the most worried and what are you doing about them?
Please Email me for a possible follow-up column. Thanks!