04.11

Urgent Retirement Planning for Boomers

The financial press is reporting that consumer debt is down, owing to an upswing in the savings rate. Part of the upswing comes from individuals who have been paying off credit card debt or student loans, while foreclosures have cut some mortgage debt. But another source of increased saving is Boomers who have realized that they need to step up savings as retirement looms. The first wave of Baby Boomers reach age 65 this year. Over the next 18 years 78 million of them will reach that age. The last wave will have time to tweak their retirement plans before the event occurs.

A common thread for Boomers is the realization that they should have started earlier to save more.

Over 50 years, the U.S. savings rate has fluctuated between more than 12 percent and near-zero. 

The personal savings rate averaged 5.8 percent in 2010, up from a low of 1.4 percent in 2005, and back to a level last seen in the early 1990s.

The average household net worth at the end of 2010 was $505,000, counting savings, financial investments, and real estate. Household debt averaged 116 percent of disposable income — the lowest in six years. The peak household debt was 130 percent of disposable income, reached in 2007.

The shift from defined benefit (DB) pension plans to defined contribution plans makes management of retirement income a more daunting task. With defined benefit plans the plan sponsor is obligated to make good on the benefits, usually a fixed dollar amount. In 1983, 62 percent of workers who had at least one pension plan had the defined benefit type. By 2007 this had shrunk to 17 percent. The percentage of workers with only defined contribution plans in the same period grew from 12 to 63 percent. A fortunate few had both types of plans — 26 percent in 1983 and 19 percent in 2007.

Most private defined benefit pension plans have a fixed payment for the life of the retiree, or a lower fixed payout if a reduced pension for the life of a worker’s surviving spouse is also elected. Many government-sponsored plans have a cost-of-living adjustment over the retiree’s lifetime that helps offset price inflation. But while private DB pension plans must comply with federal standards for fund reserves to meet future liabilities, government plans are not required to.

Strategies for managing income in retirement

The old rule of thumb was that planning for an income replacement ratio of 70 percent to 80 percent of pre-retirement income would be comfortable in retirement. The difference would be savings from avoiding work commuting costs, from paying off a home mortgage, no longer saving for retirement, and falling into a lower income tax bracket. That income would be made up of three components: a Social Security benefit, a pension payout, and dipping into savings for the rest.

But today even the replacement ratio is being challenged. Maybe 90 to 100 percent should be the retirement goal. Retirees may want to travel, at least while they are young enough to enjoy it, and that could consume funds otherwise not used. One advisor advocates living on a reduced income for a year to see how comfortable (or not) it is. Income not spent during the trial could be diverted into the retirement nest egg.

Coping with longevity

How long a retirement should you plan for? Look at your parents for a clue; if they were long-lived you probably will be too. The average life expectancy for a 65-year-old today is another 18 years — to age 83. For a 65-year-old couple, the odds are better than 50 percent that at least one of them will live beyond age 90.

Annuities are financial products that can guarantee an income for a long time — even a lifetime or more than one lifetime. Insurance companies selling them take into account interest rates — the lower the prevailing interest rate the lower the payout from an annuity. Very few have payouts indexed to inflation and those that do are quite expensive since another unknown is injected into the bet you are making with your insurer about your longevity. An immediate annuity starts making payments to the owner when purchased. Deferred annuities begin payments at some time in the future — some far into the future. One such product is Longevity Income Guarantee. The advantage is that the income can kick in when other resources have been depleted, but there are two disadvantages: you may not live long enough to reap the benefit and the effects of inflation can erode the purchasing power. 

For those who may be thinking about long-term care insurance, it can be considered in the mix of alternatives. The younger your age when such insurance is purchased, the less expensive it is. An idea of the cost can be gotten through a quick online survey of your needs from IEEE's long-term care insurance partner. 

Managing withdrawals

The longer you live, the greater the specter that inflation will seriously diminish the purchasing power of your nest egg. There is a 4 percent rule — that if you begin retirement drawing 4 percent of your nest egg each year for living expenses, investment income on the balance will likely keep you from running out of money for a long time.

A survey by the Society of Actuaries of people ages 45 to 70 showed that 37 percent felt that running out of money would be their greatest challenge if they lived to 100. For 23 percent, managing health care costs was the biggest worry. Nursing home expenses were uppermost for 14 percent. Managing savings in the face of inflation over such a long time was the main concern for 9 percent.

 With a nest egg containing a mix of 60 percent stocks and 40 percent bonds, a retiree using the 4 percent rule has a ten percent chance of exhausting his nest egg by age 97. If he stepped up the withdrawals to 6 percent per year he faced a ten percent chance of running out of money at age 82. There are numerous variations on this theme, but none comes with a guarantee of purchasing power for retirement. Currently, interest rates are very low (penalizing both the saver and the retiree), and blue chip stocks are just now recovering from the decline since 2008.

Folks counting only on their 401(k) plan for retirement are finding that the outlook is grim. A Wall Street Journal study found that for the median household headed by a person aged 60 to 62 with a 401(k) account, the account has less than one-quarter of what is needed to maintain its standard of living in retirement. Even counting Social Security and other savings, their retirement income will fall short of an 85 percent replacement ratio. At last count there were 802 comments on this article.

Most 401(k) plans contain largely tax-deferred funds. As they are rolled over into an IRA in retirement, the tax must be paid on funds withdrawn according to IRS guidelines for Required Minimum Distributions, starting at age 70-1/2.

Various strategies can be tested with online retirement income calculators. Charles Schwab, Fidelity, T. Rowe Price and Vanguard, among others, offer them. 

In 2007, the National Retirement Risk Index (NRRI) showed that even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, nearly 45 percent will be ‘at risk’ of being unable to maintain their standard of living in retirement. That is, these households are projected to have replacement rates that fall more than 10 percent short of a target rate designed to maintain their pre-retirement living standard. The target rate varies from 65 percent to 85 percent. 

The Employee Benefit Research Institute issued in February an assessment to show what the effect was of the financial and real estate crisis of 2008 and 2009 on the risk of insufficient retirement income for Early Boomer households and how much additional savings would be needed each year until retirement to make up for the losses. The simulation models showed that to maintain a 50 percent probability of retirement income adequacy there would have to be another 3 percent of compensation saved each year until retirement. To boost that to a 90 percent chance of adequacy the added saving required would jump to 4.3 percent of compensation.

Looking only at those households that had exposure to the market crisis in 2008 and 2009 from all three fronts (defined contribution plans, IRAs and net housing equity) shows a median added saving percentage for Early Boomers of 5.6 percent for a 50 percent probability and 6.7 percent for a 90 percent probability of retirement income adequacy.

The Trade-off: Retirement Age Versus Nest Egg Size

Retirement ages assumed in studies of retirement preparedness strongly affect their estimates of preparedness. Most studies estimate how financially well prepared households will be for retirement when their primary workers retire at a fixed age — typically 62 or 65. However, barring disabling injury or illness, workers can choose when to retire, just as they choose how much to save. The longer they work, all else being equal, the more prepared for retirement they are likely to be. Most studies of retirement preparedness do not treat how working just a few years longer and saving somewhat more of their income can greatly improve older workers’ financial status even if they have not saved much until they near retirement. Americans in their early 60s can typically expect to live another 20 years or so. By extending their working lives, they shorten the period of retirement that they need to finance while giving themselves more time to save and to earn returns on any assets they have already accumulated. Every year they continue to work reduces their likely period of retirement by several percent and increases the value of their assets by the annual rate of return, plus any additional saving. Moreover, by waiting to apply for Social Security benefits, workers can substantially increase their annual benefits, thus cutting the share of their retirement needs that they must finance from their own assets. For instance, although the oldest boomers will be eligible to receive 75 percent of their normal retirement benefit if they apply at age 62, they will qualify for 100 percent if they apply when they turn 66 and 132 percent if they wait until age 70.

The 2004 Congressional Budget Office study quoted above is still widely circulated. It shows that, for a 50^th percentile married couple, delaying retirement from age 62 to age 70 will cut the needed personal retirement assets by nine-tenths.

Growth in life expectancy for 65-year-olds over the next 70 years was published in the URL below.

http://www.cbo.gov/ftpdocs/48xx/doc4863/11-26-BabyBoomers.pdf

U.S. News & World Report outlines ten of the ways Baby Boomers, because of their sheer numbers,  will reinvent retirement.

George F. McClure is Technology Policy editor for IEEE-USA Today’s Engineer and the IEEE Vehicular Technology Society's representative to IEEE-USA's Committee on Transportation and Aerospace policy.

Comments may be submitted to todaysengineer@ieee.org.