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Planning for retirement is challenging. That’s especially so for those with limited resources, because they face numerous risks. 

Adding to the challenge is a major discrepancy between how pre- and present retirees perceive those risks and what empirical research shows the main risks really are, according to a recent study.

Wenliang Hou, a research economist at the Center for Retirement Research at Boston College, posited five sources of risk faced by a “typical” retiree household in his extensive 77-page analysis:

  • Mortality or longevity risk, meaning that the retiree may either die young without consuming all of the wealth or live longer than expected after exhausting all the money;
  • Market risk, such as bad stock returns or a decline in housing values;
  • Health risk, defined as unexpected medical expenses and long-term care needs;
  • Family risk, including the death of a spouse or the unforeseen needs of family members; and
  • Policy risk, mainly a Social Security benefit cut.

Hou systematically ranked these sources of retirement risk from both an objective perspective what the numbers show and a subjective one how retirees perceive them.

In other words, he asked, do individuals over 50 rank their future financial risks the same as the empirical evidence?

His analysis shows that the biggest risk in the objective ranking is longevity risk, because it affects the planning time horizon for retirement life. Health risk follows, mainly due to the unpredictability of medical expenditures in later life.

Market risk ranks third on the basis of retirees’ relatively long investment horizon, which is about 20 years for average life expectancy.

Family risk and policy risk rank fourth and fifth, respectively; the latter because Social Security reform is unlikely to significantly affect people who have already retired, Hou says. 

Related Findings

For the subjective perspective, Hou relied mainly on data from the Health and Retirement Study, a biennial longitudinal survey of some 20,000 Americans over age 50. 

In this research, market risk ranks highest reflecting what Hou calls retirees’ “exaggerated assessments of market volatility.” 

Perceived longevity risk and health risk, in second and third places, rank lower because retirees are pessimistic about their survival probabilities and often underestimate their health costs in late life, according to Hou. 

Not only that, but retirees’ shorter expected life span also intensifies their market risk expectation because it shortens their investment horizon. It also reduces their subjective health risk because they perceive a lower chance of facing uncertain medical expenses in late life.

Family risk and policy risk are at the bottom of the subjective list.

Policy Implications

There are three policy implications of Hou’s research.

First, the discrepancy in the objective and subjective rankings demonstrates that retirees do not have an accurate understanding of their true retirement risks. This, in turn, underscores the importance of educating the public on the actual sources of retirement risks. 

Second, a need exists for lifetime income products, such as annuities, which hedge longevity risk and market risk at the same time. Hou says policymakers should facilitate the inclusion of annuities in retirement plans and makes them portable between employer retirement plans.

Third, although retirees face a major risk in long-term care, they often underestimate its significance. 

“Better designed public programs and private products, possibly integrated with life annuities, could be encouraged to protect retirees with limited financial resources from this potentially cartographic risk,” Hou explains.