Retirement Readiness: A Broader Perspective

    Erik Daley, CFA
    Managing Principal

     

    Introduction

    Over the past five years or so, the retirement plan industry has refocused its attention away from participant flexibility and investment choice, to retirement readiness. Specifically, the attention has been concentrated on income replacement. An Internet search of the words “Retirement Readiness” yields a plethora of articles, white papers, surveys, and checklists that plan sponsors can employ to help participants improve their chances of meeting their income replacement objectives. Recently, while attending a popular industry conference, I attended several sessions and heard several speakers address the issue and offer their own view on solving the retirement readiness conundrum.   

    Multnomah Group confronts the challenges of retirement readiness through a white paper entitled, Addressing Retirement Readiness, which takes a slightly different view on the topic. Rather than focus on the overwhelming amounts of data available regarding participant behavior, which too often obscures what is otherwise a relatively simple math problem, Multnomah Group believes it is wise to focus on the specific factors plan sponsors can control to maximize the effectiveness of their retirement plans. 

    However, this white paper is not intended to add to the many articles on income replacement. While income replacement is a significant factor in helping participants prepare for a comfortable retirement, there are additional factors that participants must consider in order to ensure a meaningful retirement experience. This paper creates an awareness of significant obstacles that employees face as they enter retirement.  Specifically, this paper will highlight debt risk in retirement, cognitive risk in retirement, and healthcare issues in retirement.

     

    Debt Risk in Retirement 

    Debt can be a challenging part of financial planning and it can hinder achieving financial security.  With respect to retirement readiness, most retirement plan participants would benefit greatly from eliminating their personal debt.  For those participants bordering on retirement, eliminating their personal debt would be particularly beneficial because participants entering retirement without debt are better able to maintain their standard of living and reduce their level of stress.

    Mortgage Debt

    A retirement plan participant’s financial allocation towards their housing consumes the greatest portion of their income. In fact, a Forbes article from early 2013 reported that housing is a major component of debt for families age 55 and older.1  More specifically, a USA Today Article from August 21, 2014 states the following: “In fact, according to the Consumer Financial Protection Bureau, the percentage of homeowners age 65 and older carrying mortgage debt increased from 22% in 2001 to 30% in 2011. Among those aged 75 and older, the rate more than doubled, from 8.4% to 21.2%...” 2

    For retirees and participants that are near retirement and still maintain a monthly mortgage, this can consume a significant percentage of their household income and reduce their ability to enjoy a comfortable retirement. According to Bankrate.com, as a general guideline, a participant’s monthly mortgage payment should not exceed 28% of their income. This includes principal, interest, taxes, and insurance.3   

    As retirees and pre-retirees carry larger mortgages into retirement, and when those mortgages exceed 30% of their household income, the financial risk increases significantly. This means that retirees must reduce household expenses in other areas. This is a difficult task when other household expenses, like healthcare costs, are increasing at an alarming rate. In order to eliminate many of these risks, pre-retirees should consider whether or not they want to enter retirement with a mortgage.

    Credit Card Debt

    Credit card debt is a growing problem for retirees that are on a fixed income. Pension giant TIAA-CREF reported the following: “The average debt level for families headed by individuals age 75 or older more than doubled to $27,409 in 2010 from $13,665 in 2007, according to the Employee Benefit Research Institute (EBRI)."4 

    This rising debt for retirees may result from a variety of reasons. The rising cost of healthcare costs coupled with the increase in care that accompany many seniors can lead retirees to seek relief in the form of their credit cards. In addition, like most Americans, family obligations can force retirees to use credit cards as a resource to help them make ends meet. 

    Coupled with a mortgage, credit card debt can seriously impact a retirement plan participant’s plans for their future. Not only can too much debt impact a retiree’s standard of living, it may mean postponing retirement indefinitely.

    While entering into retirement without debt may not be a likely scenario for most retirees, it is a topic that deserves more attention in the conversation of retirement readiness.

     

    Cognitive Risk in Retirement

    Retirement can have its advantages. Less stress, travel, and enjoying your hobbies are some of the aspects of retirement that make those "Golden Years" so appealing. However, one of the challenges as we age is our ability to maintain our mental acuity. A quick search on Google produces a myriad of articles on the emotional and mental aspects of retirement. Organizations such as AARP offer a wealth of information for retirees on keeping active and maintain mental sharpness. 

    Retirees making portfolio decisions, or handling their own asset allocation or retirement plan distribution strategies need their mental acuity at the time of making these important decisions regarding their retirement funds. How much should they distribute? How will this impact their taxes? How much should be invested in fixed income securities? These are lofty questions and they require careful consideration. However, this is also a time when they may be experiencing a decline in their financial literacy. Research conducted by Michael Finke, an associate professor at Texas Tech University, indicates that retirees begin to lose their financial aptitude as they age.5 

    How do participants near or entering retirement prepare for this challenge?  Here are a couple of steps this population may want to consider. First, there must be an awareness and acknowledgement that as we age we lose some of our mental acuity. Without this understanding we may be overly confident in our ability to handle our assets. Next, plan for future asset allocation decisions. For some, this may be an opportunity to hire an advisor that can help them as they plan for retirement. For others, this may be an opportunity to revisit annuities. Many articles have been written disapproving of annuities. However, these insurance products are intended to ensure we don’t outlive our assets, and can help eliminate the need to constantly monitor your asset allocation.

     

    Health Care Costs in Retirement

    This topic deserves a much longer and in-depth discussion as it is on the minds of many retirees and retirement plan providers. The rising cost of healthcare is chomping away at retirement nest eggs. Costs are not limited to the big ticket concerns like hospital stays and treatment for acute illnesses; prescription drugs, preventative care, and long-term care costs are also rising significantly.

    There is no magic solution. To date, the federal government’s attempts at addressing these issues (through the Affordable Care Act) haven’t seemed to stop the rising costs of healthcare. Retirees must understand these challenges and begin preparing. For example, as they enter the retirement red-zone (the 5-10 years before they retire) they should consider a long-term care policy. Pre-retirees should also consider out-of-pocket healthcare costs and the potential gaps in insurance that may not cover all medical care needs. They must also ask themselves the difficult questions, “What if I need a nursing home? What if I need in-home care?" While these are challenging questions, they significantly impact the quality of our retirement.

     

    Summary

    These are not the most exciting topics to address and perhaps this is the reason why many retirement plan providers are not discussing these issues as much as they should. However, they are real world challenges for participants that will be entering retirement and for those in retirement, and are issues that impact an employee’s retirement readiness. Arguably, they are perhaps just as significant as a retirement plan participant’s income replacement ratio. 

    As plan sponsors and retirement plan providers work together to solve important savings rate issues, retirement readiness issues, and overall plan design issues, they should also help participants understand the challenges and reality of living in retirement.