Data and Research September 11, 2017

Improving Retirement Outcomes Considering Low Returns and Longevity

In addition to saving more and working later, researchers from State Street Global Advisors suggest policy changes that could improve retirement readiness for younger workers and late savers.

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In a Pension Research Council working paper, Catherine Reilly, senior investment strategist, defined contribution, at State Street Global Advisors (SSGA), and Alistair Byrne, head of investment strategy, European defined contribution, at SSGA, state that expected low market returns paired with increasing longevity will make it tougher for future retirees to have sufficient income replacement rates in retirement.

After performing an analysis based on certain assumptions so that only the effect of lower expected market returns is measured, the researchers find that a hypothetical individual currently 60 years old and who retires at age 65, having been saving since age 22, could expect to achieve a 211% replacement rate from his defined contribution (DC) savings alone. In addition, he can expect to receive Social Security and may well have some defined benefit (DB) plan benefits as well. The paper authors note that while few 60-year-olds may have been in a DC plan since the age of 22, they could have made contributions to a retirement savings account by themselves.

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By contrast, an individual currently 25 years old and who employs the same saving strategy could expect to achieve a 27% replacement rate from his DC plan if he was to retire at age 65. Furthermore, the younger individual is unlikely to have any DB entitlements and faces more uncertainty regarding the amount of Social Security that he will receive. The researchers note a 45-year-old individual can expect better outcomes than the 25-year-old but is also disadvantaged compared to the 60-year-old.

The researchers contend that the most obvious tactics that younger workers could adopt to improve their situation are to contribute more and to work longer. For example, a 25-year-old could reach a 40% replacement rate by contributing about 13.5% and working until age 65; by contributing slightly above 10% and working to age 70, or by contributing about 7% and working to age 75. A 35- or 45-year-old benefits from stronger historical returns, so either can achieve the target replacement rate at slightly lower contribution rates. The researchers also note that individuals who start the retirement saving journey late face more challenges, yet they can also significantly improve their retirement readiness with a disciplined approach to saving and by postponing retirement.

However, this assumes consistent savings behavior during the entire working life, no career breaks, and no leakage from retirement savings.

Suggestions to Improve Retirement Readiness

The researchers suggest policy changes that could improve retirement outcomes for younger individuals and/or late savers. One alternative policy would be to allow individuals to take out partial Social Security benefits rather than obliging them to always take the full benefit. For example, the paper notes, in Sweden, people who have reached the minimum age of eligibility for Social Security (62) can take a 25%, 50%, 75%, or 100% benefit, and modify this percentage when desired at an actuarially fair rate. There is also no maximum age by which full payments must start. Another option would be to give people a choice to defer the start of Social Security benefits beyond age 70, to make the most efficient use of Social Security’s cost-efficient longevity insurance. “This would make it possible to use Social Security as a longevity backstop providing the main source of income in late life, rather than a steady source of income throughout retirement,” the paper says.

As an example, the researchers note that in Australia, eligibility for the Age Pension is based on an asset test, reassessed annually, rather than retirees’ age. People are not eligible for the Age Pension until they have drawn their assets down to a minimum level, after which they receive a flat rate Age Pension for the rest of their lives.

Other than Social Security policy changes, the researchers suggest mandating automatic enrollment in DC plans and automatically escalating contribution rates would be effective for improving retirement outcomes. In addition, they note that matching contributions encourage voluntary employee contributions up to the match threshold. Reducing retirement plan leakage would also be helpful.

The researchers note that although some people may not be physically able to work full-time past retirement age, part-time work may be feasible for many.  A question the researchers posed, but did not address fully is how employers will facilitate and value older workers.

The full working paper is available here.

Benefits September 11, 2017

Analysis Projects Huge Retiree Health Care Expenses

“Adding deductibles, copays, hearing, vision, and dental cost sharing, the number grows to $607,662 in future dollars,” the research states.

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HealthView Services has published the 2017 Retirement Health Care Costs Data Report.

Similar to other recent research results, the findings frankly are grim in many respects for retirement savers. At a minimum, the research suggests retiree health care expenses will rise at an average annual rate of 5.47% for the next decade or more. Such a rate is almost triple the U.S. inflation rate from 2012 to 2016, which stood at a mere 1.9%, and more than double annual projected Social Security cost-of-living adjustments retirees can depend on.

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Other findings show, because of longer life expectancies, women will continue to pay more for total lifetime health care than men.

It’s not all bad news, however. Beyond making a strong argument for the use of long-term health savings accounts to address the massive amounts of cash retirees are expected to spend on health care, for the first time, the 2017 Report highlights and quantifies the real and measurable financial benefits associated with behavior modification.

“Americans are not powerless when it comes to reducing costs … Current data show that Americans with specific medical conditions, such as type II diabetes or high blood pressure, have some control over their longevity and health expenditures if they actively change behaviors and follow prescribed treatments,” the firm reports. “Those who manage their conditions can extend life expectancies, save money, and offset future medical expenses.”

The report points to one case study involving a 50-year-old with type II diabetes. Proactive management of the condition can mitigate the associated treatment expense and increase annual in-retirement income by almost $17,000. Naturally, some potentially difficult lifestyle changes and careful adherence to diabetes-care protocols will be required, but it should be encouraging to see that real solutions are possible, even for those with challenging medical conditions.

Specific expense projections are sobering 

According to HealthView Services, total projected lifetime health care premiums for Medicare Parts B and D, supplemental insurance, and dental insurance for “a healthy 65-year-old couple retiring this year” are expected to be $321,994 in today’s dollars, or $485,246 in future dollars that account for inflation projections.

“Adding deductibles, copays, hearing, vision, and dental cost sharing, that number grows to $607,662 in future dollars,” the research states. “Medicare Part B premiums grew by 16% in 2016. The Medicare Board of Trustees originally projected a 24% Part-B decrease for 2017, but instead, premiums increased 10%.” The Trustees estimate a 1.3% decrease in 2018, the report clarifies. Also, the average cost of supplemental insurance will rise at 7.12% per year, driven by annual projected premium inflation of 3.80% and an additional annual age-based increase of 3.32%.

HealthView’s Retirement Health Care Cost Index shows that a 66-year-old couple retiring this year will require 59% of their Social Security benefits to cover total retirement health care costs.

“A 55-year-old couple will need 92% of benefits, and 45-year-old couple, 122%,” the report warns. “Women will face higher lifetime health care costs because they will live, on average, two years longer than men. Expected health care costs (for Medicare Parts B and D, a supplemental insurance policy, and all out-of-pockets) for a healthy 63-year-old woman retiring this year (living to age 89) are projected to be $362,607 in future dollars, or 29.9% more than a 65-year-old male ($279,176).”

The report concludes that health care will undoubtedly be one of the most significant retirement expenditures for many; however, the annual savings required to cover this expense may seem more reasonable if individuals consider investing more aggressively for retirement over longer periods of time. For example, a Millennial entering the work force has a fairly good chance of meeting these worrying figures if they invest regularly in a health savings account (HSA) during the course of their working lifetime. 

The full research report can be downloaded here. 

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