Many relatively affluent boomers have less money saved for retirement than they may need, a new study by Barclays Global Investors N.A. suggests.
Americans in the mid-to-upper levels of wealth typically think that government programs combined with home equity and retirement savings will give them ample funds for a comfortable retirement. If so, they could be in for an unpleasant surprise, according to the report by BGI, San Francisco, a unit of Barclays Bank P.L.C., London.
Low savings rates among Americans means many plan to rely heavily on future savings from wages, the equity in their homes and Social Security to finance their retirement. BGI’s study, however, concludes that those resources will be disappointing if not downright inadequate, even for the relatively well-to-do.
“When you factor in shocks to future government benefit programs as well as home equity, large portions of the U.S. population are tenuously prepared for retirement,” said Matthew H. Scanlan, head of BGI’s Americas Institutional Business. Scanlon, along with Jonathan Cohen, BGI’s senior income strategist, and Matthew O’Hara, head of its securitized credit research unit, coauthored the study, “The Future Shock of Retirement.”
The authors see reason to dispute the “surprisingly benign” estimates that some recent studies have made about the financial strength of Americans approaching retirement. Widely held assumptions about living costs and government benefits remaining stable are unrealistic, they warn.
Their look at government programs such as Medicare and Social Security as well as corporate pensions and personal savings found reasons for alarm.
For instance, most individuals take it for granted that government benefits are irrevocable and that they will enjoy their current or even better wages until retirement. They also assume the value of their houses will appreciate.
Among the potential shocks the BGI researchers foresee are increased out-of-pocket medical costs stemming from cutbacks in government programs. They subtracted $7,000 per year from projected retirement incomes of middle-to-upper income households under the assumption that means-testing for Medicare would eliminate the benefit for this group. This would require those affected to buy healthcare privately.
As for home equity, the study made the point that even if a consumer downsized their home upon retirement to capture their home’s appreciated value, they would still need to live somewhere. Projecting these costs, which they call “imputed rent,” and using an inflation assumption, they then calculated the present value of an annuity that would make these rental payments from the date of retirement until the projected date of death. Using this method, they reckoned the typical retiree would use about 41% of the current market value of his house for shelter during his lifetime. The remaining 59% would be available for consumables.
The results of these shocks to government benefits and adjustments to home equity show that middle-to-wealthier income groups could lose from 20% to 28% percent of their total wealth in retirement, the study concludes.
The paper shows that the retirement preparedness for a broad range of income groups would change radically if government benefits are reduced, or means-tested, and housing prices become more volatile, notes Scanlan.
“To avoid a retirement crisis, substantial changes in the behavior of government, the private sector and individuals will all be required,” Scanlan said.
For financial advisors and asset managers, the main activities to consider include designing 401(k) and other defined-contribution plans to incorporate the best features of defined benefit plans–in effect, “the DB-ing of DC,” the authors say.
“The Pension Protection Act of 2006 and related Department of Labor regulations provide fiduciary protection to DC plan sponsors adopting the kinds of practices we recommend–automatic enrollment, high default contribution rates and default investment options that are properly diversified across asset classes,” Scanlan said.
The continued development of lifecycle funds is also important, according to the study. These are DC investment products that target risk to the age of the investor and his or her distance from retirement. Lifestyle products will need to evolve toward tailoring plans more to investors’ risk tolerance, the authors contend.
Plans can also offer products that enable the plan sponsor’ to target its matching contribution to investments that provide employees with a strong opportunity to accumulate adequate wealth, the authors suggests.
For example, high-income households that have accumulated relatively low wealth might be offered a strategy focused on additional risk aimed at catching up to a level of appropriate wealth, they say.
Individuals will have to take a more active role in managing their own retirement security, they conclude. Of prime importance is learning that their assets won’t last forever and hence must be annuitized in some way.
“Plan sponsors and financial service providers must place special emphasis on expressing retirement account balances in terms of annuitized income,” Scanlan said. “This sounds like a simple adjustment, but as most plan sponsors know, attempts to change behavior face a considerable challenge.”
BGI’s research was based on data from a 2004 update of the University of Michigan’s Health and Retirement Study (HRS). To examine the financial health of a segment of the baby boomer generation, BGI restricted its analysis to households in which the oldest household member was between 51 and 61 years old at the time of the survey.