Even if households work to age 65 and annuitize all their financial assets, more than half are at risk in retirement, according to federal data.
This month's article is the fourth in a new series called "Behavioral Finance and Retirement," which is intended to provide insight to advisors on the unique needs and financial behaviors of clients who are entering that period of transition called "retirement."
I put retirement in quotation marks because people today are not retiring the way they used to. The days of the retirement party, the gold watch, and sitting out one's years doing crossword puzzles and watching "Wheel of Fortune" are over for most people.
We've all heard the analogy that the baby boomers are like a baseball going through a garden hose. Well, the baseball is getting to the end of the hose, and it's not leaving without a bang! And before it leaves, it will be a financial force to be reckoned with.
To serve retired clients properly, there are some key themes that advisors need to be aware of:
1. People are living longer than ever thanks in part to medical technology and better living habits such as diet and exercise. This is extending the length of time people are in a nonworking phase of life.
2. People's definition of retirement is changing, which is having a major impact on how individuals manage their finances.
3. In some cases, a certain segment of the population will have no choice but to produce some type of income after they leave the traditional workforce.
4. The responsibility of planning and investing for retirement has shifted in large part to the employee/retiree and away from corporations. As a result, behavioral biases significantly affect individuals who are entering or already in this phase of life.
Today many people are bumping up against the time when either they are no longer desired in the traditional workforce, no longer wish to be in the traditional workforce, or both. As advisors, we need to get inside their mindset as these events unfold.
The first step to getting a grasp on this issue is to understand how people are currently defining retirement. Many pre-retirees have a new vision of what they want to do after they leave the traditional workforce--and many want to do something useful and productive. These folks seek intellectual and social engagement. If people want to do something like this full-time, they need to know if they can afford it. Those advisors who can step up their game and embrace these trends will be successful going forward. Those who think of retirees as they have traditionally will likely have challenges.
Once you grasp these stats, you can begin to address the behavioral aspects of why many people are ill-prepared for retirement.
In this article and the next we will explore the statistics associated with retirement. As an advisor you need to know the state of retirement in terms of what people are doing and--to preview what you will be reading--the lack of planning that is going on. Once you know the numbers, you can then move on to step two, which is addressing the behavioral aspects of why many people are ill-prepared for this stage of their financial lives.
Important Retirement Statistics
The source I turn to first when seeking info on retirement issues is the Federal Reserve's Survey of Consumer Finances (SCF), which comes out every three years. The last one is from 2013. This is a great opportunity to understand Americans' retirement preparedness. The "measuring stick" used is The National Retirement Risk Index (NRRI).
The NRRI shows the share of working-age households who are "at risk" of being unable to maintain their pre-retirement standard of living in retirement. It is constructed using the SCF, a triennial survey of a nationally representative sample of U.S. households that collects detailed information on assets, liabilities, and demographic characteristics. For SCF households, the NRRI compares projected replacement rates--retirement income as a percentage of pre-retirement income--with target rates that would allow households to maintain their living standard and calculates the percentage at risk of falling short. The NRRI was originally created using the 2004 SCF and has been updated with the release of each subsequent survey.
In 2013, the NRRI shows that 52% of American households were at risk. That means today's workers face a major retirement income challenge. To wit, even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, more than half are at risk in retirement. Although 2013 was a "good" year from the standpoint of rising stock market and rising home prices, the NRRI actually went down only 1%, meaning that more people were prepared for retirement but still over half of working people are unprepared.
According to the report:
Our expectation was that the NRRI would improve sharply in 2013; it certainly felt like a better year than 2010. The stock market was up, and housing values were beginning to recover. But the ratio of wealth to income had not bounced back from the financial crisis, more households faced a higher Social Security Full Retirement Age, and the government had tightened up on the percentage of housing equity that borrowers could extract through a reverse mortgage. On balance, then, the Index level for 2013 was 52%, only slightly better than the 53% reported for 2010 (see Figure below from the report).
The "macro" picture of this trend is a troubling for the broad population. Since 2010, the increase in the stock market, which affects mainly the wealthiest Americans, has been very strong. Between the third quarter of 2010 (which marks the previous NRRI baseline) and the third quarter of 2013, stock prices increased by about 40%, after adjusting for inflation. These gains have been concentrated in the top third of the income distribution, which hold about 90% of all equities. The increase in the value of housing, which is much more widely held, has been modest. A broad rise in housing prices would help increase preparedness.
There are a few other factors that contributed to increasing the NRRI. These were the rise in Social Security's Full Retirement Age (FRA), the decline in interest rates, which decreases cash flow on fixed-income securities, and new reverse mortgage rules that lowered the percentage of home equity that is available at various interest rates.
With regard to the FRA, the transition of the FRA from 65 to 67 will continue to push the NRRI higher. According to the study: Under legislation enacted in 1983, the increase in the FRA began with those born in 1938 (who turned 62 in 2000) and will be fully phased in for those born in 1960 (turning 62 in 2022). In 1983, about half of working households could claim full benefits at 65. By 2001, almost all working households were required to wait until at least 66 and many until 67 to receive full benefits. Since then, the share of households required to wait until 67 has continued to increase. As the FRA goes up, benefits at 65--the assumed retirement age in the NRRI--decline. This decline affects all households but has a particularly large impact on low-income households who depend almost entirely on Social Security for retirement income.
If half of Americans are unprepared for retirement, the implication is that people are not doing enough advanced planning. This issue was covered in more detail by a different study done by Genworth, which demonstrated in a direct way that people are not doing enough financial planning--and this is where the rubber meets the road, as you know.
Intellectually many people understand there is a problem with this issue, but many people aren't turning the knowledge into an action plan. As you can see by the chart below, even those who are above 55 years old, only 31% contribute to an IRA and 35% contribute to a 401k. There are many behavioral impediments that are getting in the way to better planning and saving which we will review in the next several articles.
But perhaps the biggest news of all to come out in the survey: Only 25% met with a financial advisor! What a huge opportunity!