Assessing the Risks Workers Face Going Into Retirement

The Center for Retirement Research at Boston College has released a new analysis examining both the financial risks retirees face and how retirees perceive them.

According to the brief, titled “How Well Do Retirees Assess the Risks They Face in Retirement?,” recent studies have identified five major risks: the risk of outliving one’s money (longevity risk), the risk of investment losses (market risk), the risk of unexpected health expenses (health risk), the risk of unforeseen needs of family members (family risk) and the risk of retirement benefit cuts (policy risk).

The analysis shows that these risks affect different cohorts of the working population differently. For example, for single men reaching retirement, the top three sources of risk are longevity, health and market risk. According to the CRR, the typical single man would be willing to give up as much as 27% of his initial wealth to fully eliminate longevity risk.

Health risk ranks second in this cohort due to the unpredictability of medical expenditures in late life, including the cost of long-term care, the brief says. Market risk ranks third due to retirees’ relatively long—about 20 years—investment horizon. The brief suggests that policy risk is small because Social Security reform is unlikely to have a significant impact on people who have already retired or who will do so soon.

The risk ranking for married couples was similar to the results for single people, though the relative value of the risk is larger overall for couples, the brief says. This means that a couple would be willing to give up 33% of their initial wealth to avoid longevity risk, compared with 27% for a single man.

The brief also shows the most serious subjective risks perceived by different groups tend to be different from their actual risks. For example, for single men, market risk tops the list of perceived risks, followed by longevity, health, family and policy risks. According to the CRR, single men and couples alike tend to significantly underestimate their medical expenses in old age.

Perceived longevity risk and health risk rank lower because retirees are pessimistic about their survival probabilities, the brief says. This implies that retirees do not have an accurate understanding of their true retirement risks.

Additionally, the analysis highlights the importance of longevity and market risk, which underscores the need for lifetime income either through Social Security or private sector annuities, the brief says. Long-term care is also a significant risk faced by retirees that they often underestimate. Better-designed public programs and private products, possibly integrated with life annuities, could help to protect retirees with limited financial resources from this potentially catastrophic risk, the brief concludes.