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The View From Unretirement: You may be planning for retirement all wrong

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If retirement is nearing (however you define retirement personally), it’s understandable that you’re worrying about the risks you’ll face. But you just may be worrying too much about the wrong ones.

That’s the conclusion of economist Wenliang Hou and the basis of a recent paper he wrote for the Center for Retirement Research (CRR) at Boston College, “How Well 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 retirement risks

Basically, Hou says, there are five major risks in retirement:

·      Longevity risk — the risk you’ll outlive your money

·      Market risk — the risk of volatility in the stock market and housing market

·      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

·      Policy risk — the risk of the Social Security Trust Funds’ insolvency, leading to a 20% to 25% reduction in retirement benefits if there are no policy changes

Hou compared the actual risks of each (known as objective or empirical risks) with how people assess the probability of those risks (known as subjective risks). To do this, he reviewed the University of Michigan’s biennial Health and Retirement Study, which surveys about 20,000 people over 50, and then looked at the data.

What he found: “People underestimate their longevity, and they overestimate the volatility of the market,” Hou told me.

What people fear most vs. the reality

More specifically, Hou ranked the public’s view of their retirement risks in this order: market risk, longevity risk, health risk, family risk and policy risk. But their real retirement risks, he discovered, are in this order: longevity risk, health risk, market risk, family risk and policy risk.

“Longevity is the most important risk because people need to allocate their resources over the retirement horizon to make decisions,” says Hou.

People who aren’t being realistic about how long they might live might, as a result, not save as much as they need to or spend more in retirement than what’s wise.

Also, says Hou, “they may make the wrong decisions regarding when they stop working and start claiming Social Security benefits.”

Quitting 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 size of your retirement benefit compared with waiting until your mid- or late-60s. You get 8% more from Social Security for each year you delay claiming between your Full Retirement Age (now typically 66 to 67) and age 70.

Read MarketWatch’s Help Me Retire column

The longevity goof we make

Americans often predict their longevity based on the age their parents died, which may be in their 70s, Hou says. But we’re generally living longer than our parents did.

The actual mortality statistics say that today’s 65-year-old male in the United States can expect to live, on average, to about 87; a 65-year-old female to about 89.

The expected lifespans for men and women have jumped by more than 10% since 2000, according to the Society of Actuaries, author Mark Miller notes in his excellent forthcoming book, “Retirement Reboot: Commonsense Strategies for Getting Back on Track.”

Averages being averages, it’s possible you’ll live into your 90s or 100s — or not. Of course, it’s impossible to know exactly how long you’ll live. Your genes play a role. So does your current health, your future health, your health history, the possibility of an accident or becoming a crime victim and simply the unexpected.

I’m 66 and the rudimentary (and, all right, slightly morbid) Actuaries Longevity Calculator computes 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’m factoring those numbers into my retirement planning.

Market risk: Real, but not as bad as you may think

As for market risk, Hou wrote that “individuals on average have very pessimistic and larger volatility expectations than the empirical data indicate.” In fact, their expectations for market volatility are almost double than what the data show.

Here’s the problem: “If you feel you’re going to lose a lot of money, you stop investing. And that’s not ideal,” says Hou. “Should we stop investing from a long-horizon perspective? I’d probably say, ‘No.’”

I understand why so many are so nervous about the volatility of the stock market shrinking their retirement savings. So does Hou. “People are exposed to the daily news headlines [about market volatility] and that’s something they keep in mind,” he acknowledges.

But, Hou explains, by living a longer life, you also wind up reducing the negative effect of any one year’s stock market volatility on your retirement.

Read: This is the ‘secret sauce’ to retirement satisfaction

How stable lifetime income can help

Since longevity and market risks are risks No. 1 and 2 for retirement, he says: “it’s better to have stable lifetime income resources” to cover them.

That could mean buying an annuity with some of your savings (an insurance company product providing set monthly income). Or it could mean converting a portion of your 401(k) to 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, chief executive of the Alliance for Lifetime Income — the insurance industry’s educational group on annuities — told me: “There’s steady income that you can get in retirement that is guaranteed and protects you from the ups and downs of the volatile market. The answer to risk is certainty, and annuities provide certainty.”

But few people buy immediate annuities in retirement — the kind that start delivering monthly income soon after you buy them. 

In a 2021 CRR paper, Hou and two colleagues wrote that “the U.S. market for immediate annuities is minuscule.” Their sales in 2018 totaled $9.7 billion while long-term care expenditures amounted to roughly $150 billion, they noted. The authors said some people shun annuities because the products are expensive; some don’t like the idea of handing over control of their life savings to insurers.

Statler says her group’s research shows a third of financial 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, the Alliance’s chief communications officer Cyrus Bamji adds: “There’s a huge gap between what clients are asking and looking for — which is some type of protected income — and what advisers think they want. It’s one of the gaps we are working to try to close.”

Social Security also provides stable lifetime income, effectively in the form of a monthly annuity.

“I would say Social Security is the best option for annuitized income for retirement,” Hou notes. “And if people can delay claiming Social Security to fit into their real risk, that will be better.”

Monthly benefits for people who delay claiming Social Security until 70 (something few can afford to do) are at least 76% higher than those claimed at 62.

Planning for health risks in retirement

Health risks in retirement, or more pointedly healthcare costs in retirement, are essential to consider and plan for. But they’re also often underestimated, Hou says. In his research, he notes, “you can really see the big gap for late-life medical expenditures” between what people expect to pay and what they really pay.

According to Fidelity Investments’ annual projection, an average 65-year-old retired couple may need about $315,000 to cover their healthcare 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 the Genworth Cost of Care Study. In assisted living, it’s $54,000. A home health aide runs $61,776.

As Hou wrote: “Long-term care is a significant risk raced by retirees, but one they often underestimate.” 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’d love to know: What retirement risks are you most worried about, and what are you doing about them?

Please email me for a potential follow-up column. Thanks!

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