We havent been hearing much lately about retirees facing severe financial hardships. Personal investment portfolios have rebounded with the stock market, home prices are up, pension plans are somewhat better-funded than a few years ago, tax reform didnt cut Social Security, and active retirees often can pick up part-time jobs if they want, amid a strong economy.
But the future doesnt look as promising, with several forces likely to increase the financial "fragility" of people planning to retire years down the road, especially younger Baby Boomers and Gen-Xers. Thats the upshot of a paper that reviewed various recent studies on retirement readiness.
"While a small share of todays retirees are financially fragile, most appear able to absorb a financial shock, at least for a time, without a substantial reduction in their standard of living," wrote Steven Sass, a research fellow at the Center for Retirement Research at Boston College. But future retirees, he added, might not have it so good.
Here are some of the key issues and concerns outlined in his report:
In future years, retirees will derive less of their overall income from Social Security and traditional pensions, two historically stable sources. Pensions have been declining in relevance for decades, with fewer younger workers gaining access to them, and even Social Security could become less important.
Assuming Social Security is able to continue paying all benefits as promised, the gradual increase in full retirement age means younger workers will need to wait a bit longer to collect full benefits compared to their older siblings and parents. Also, more retirees are paying taxes on at least some of their Social Security benefits (job, pension and other income can make up to 85 percent of Social Security taxable). Rising Medicare premiums are another potential drag cited in the paper.
That means Americans will need to rely increasingly on personal savings, including assets held in Individual Retirement Accounts and workplace 401(k)-style accounts. The advantage here is that people have the ability to earn higher returns than what they can get through Social Security, but the drawback is that many Americans have been negligent about funding these accounts.
"Many households retiring over the next quarter century could lack sufficient savings," wrote Sass in an understatement. Meanwhile, "Social Security will replace a smaller share of earnings."
People in retirement face two main types of financial threats — spiking medical expenses and a decline in income when a spouse dies, especially when women become widows.
Medical costs typically rise at older ages, though health insurance, family contributions and savings help to meet these outlays. It remains to be seen whether these other sources of assistance, including Medicare, will remain as reliable as they are currently.
As for widows, most Americans enter retirement as married couples. But wives typically outlive their husbands, causing financial pressure when the husband dies. One study cited by Sass indicated widows receive only about 62% of the couples prior combined Social Security benefits and only half their prior employer pension benefits (for couples fortunate enough to have pensions). Yet widows (or widowers) generally need about 79% of the couples previous income to maintain a similar standard of living.
Retirees are often described as living on a fixed income for a reason, as older Americans typically dont have many opportunities to augment the flow of money coming in.
Yet expenses often rise. The report cited research indicating 80% of spending by a typical elderly household goes to five basic areas: housing, health care, food, clothing and transportation. That leaves the remaining 20% for entertainment, gifts, cable TV, cell phones and all other disbursements.
These latter areas typically are the first to be cut if income drops or if spending rises on necessities. Stated differently, retirees typically cant cut spending by more than 20% without facing hardship, Sass wrote. For low-income households, the margin is even slimmer.
Financial advisers commonly cite 4% as the maximum amount that people could withdraw from an investment portfolio each year without seriously dipping into their principal. For example, if you had a $500,000 portfolio, you could withdraw about 4% of that, or $20,000 each year, without eroding the balance much. However, "Many experts now think that a 4% drawdown rate is too high, given rising longevity and potential declines in investment returns," Sass wrote.
The 4% rule assumes that people are willing to hold about half their portfolios in the stock market, in hopes of generating higher long-term returns, yet many Americans are much more conservative than this and avoid equities. The rule also assumes that withdrawals are made during years when the stock market is rising. When people are forced to pull out cash during bear markets, they risk serious damage to their portfolios, as there will be smaller remaining balances able to recover in any subsequent market rebound.
People nearing retirement can shore up their financial readiness by boosting income and cutting expenses — but neither of those steps are necessarily easy. Specific solutions cited by Sass include: Downsizing into a smaller home to reduce costs, working longer to boost income, buying annuities to secure steady income and even taking out a reverse mortgage (if you own a home) to lock in steady income.
But most of these options are neither popular nor widely practiced.
"While many individuals are already working somewhat longer, retirees rarely annuitize, downsize or take out a reverse mortgage," he wrote. "Whether the prospect of increased financial fragility leads them to change their behavior remains to be seen."