Many members of the next generation of retirees are expected to face a large decline in their standard of living when they retire, according to a new report.
The report, from the Society of Actuaries, found that making retirement decisions based on averages increases the risk of running out of money, Moderate and higher-income households can successfully retire with 20 percent less savings if they are willing to cut their discretionary budgets by 15 percent, according to the report. Purchasing an annuity must be balanced against the need for an adequate emergency fund. Purchasing long-term care insurance reduces emergency fund needs for lower income and wealthy households.
The report also found that continuing mortgage payments in retirement increases the likelihood of income shortfall. Social Security benefits are extremely important at lower income levels, and delayed retirement is the most impactful risk-mitigation strategy, especially for the median family. Early retirement requires significantly greater assets at retirement unless major budget reductions are implemented.
"Many of the next generation retirees are facing a big drop in their standard of living when they retire and individuals need to be aware that attempts to over-simplify the retirement planning process can be very dangerous if used for personal decision making," said actuary Anna Rappaport, who co-authored the report. “Planning for so-called shock events, such as expensive health shocks or ill-timed financial market downturns, must be taken into consideration since they are more likely to derail an individual's retirement plan, especially at lower income levels. Less than one-third of median households will have positive wealth at death."
The median American married couple at retirement earns approximately $60,000 a year and has approximately $100,000 in non-housing wealth, the report noted. There is a 29 percent chance that median households will have positive wealth at death. The assets needed to meet cash flow needs 50 percent of the time would be approximately $170,000 compared to approximately $686,000 for a 95 percent success rate.
“There is no ‘one-size-fits-all’ measure of benefit adequacy and there are many ‘moving parts’ depending on the purpose and the stakeholder using it,” the report warned. “Individuals need to be aware that attempts to over-simplify the retirement planning process can be very dangerous if used for personal decision making.”
The most appropriate measure of retirement benefit adequacy depends on the stakeholder, whether it's a plan sponsor/employer; financial planner/individual; public policymaker; or financial institution.
While it is much easier to plan for expected events, unexpected events must be taken into account as they are more likely to derail an individual's retirement plan, especially at lower income levels. For the median income individual, “shock events” are the largest driver of asset depletion.
The purchase of retirement annuities must be balanced against the need to maintain an adequate emergency fund. While annuities can protect against longevity risk, they can also divert assets that would otherwise be available to deal with shock events. Even after a retiree’s wealth has been depleted, however, a continuing annuity income stream helps meet ongoing cash flow needs.