Alicia Munnell, director of the Center for Retirement Research at Boston College, wrote a piece for Smart Money on Monday that zeroed in on the reasons retirement will be so much riskier for Baby Boomers than their parents and grandparents.
According to Munnell, the current crop of retirees are living in a “golden age” that will fade as Baby Boomers and Generation Xers reach traditional retirement ages in the coming decades.
“Many Baby Boomers and Gen Xers face a significant retirement income shortfall,” she writes. “Even before the financial crisis, almost 45% of working households were projected to be ‘at risk’ [of being unable to maintain their pre-retirement standard of living in retirement]; after the crisis, this level increased to 51%.
Moreover, Munnell (left) adds, the percent "at risk" increases with each cohort. Late Boomers show more households "at risk" than early Boomers, and Generation Xers have even larger numbers "at risk." This gloomy forecast is due to the changing retirement income landscape.
She then lists the four reasons why today’s workers will be retiring in a substantially different environment than their parents:
1. They're living longer – The length of retirement is increasing, as the average retirement age hovers at 64 for men and 63 for women while life expectancy continues to rise. This longer retirement means retirees will likely need more savings than their parents’ did.
2. Replacement rates are falling – Replacement rates – retirement benefits as a percent of pre-retirement earnings – are falling for a number of reasons. First, Munnell notes, at any given retirement age, Social Security benefits will replace a smaller fraction of pre-retirement earnings as the full retirement age rises from 65 to 67. Second, while the share of the work force covered by a pension has not changed over the last quarter of a century, the type of coverage has shifted from defined-benefit plans, where workers receive a life annuity based on years of service and final salary, to 401(k) plans, where individuals are responsible for their own saving. In theory, 401(k) plans could provide adequate retirement income, but individuals make mistakes at every step along the way and the median balance for household heads approaching retirement is only $78,000. Third, most of the working-age population saves virtually nothing outside of their employer-sponsored pension plan.
3. Out-of-pocket health costs are rising – Out-of-pocket health costs are projected to consume an ever greater proportion of retirement income.
4. Returns have declined – Asset returns in general, and bond yields in particular, have declined over the past two decades so a given accumulation of retirement assets will yield less income.
She concludes that it is important to note her research is based on conservative assumptions.
“Everyone is assumed to retire at 65; they don’t, they retire earlier,” she writes. “Everyone is assumed to tap the equity in their home through a reverse mortgage; only a fraction of those eligible elects this option. All financial assets are assumed to be annutized so that retirees gain the maximum income from their assets; in fact, annuitization is rare; in short, [we] probably understate the challenges ahead.”