A Moving Target

Trying to figure out how much money an individual or couple needs to live on in retirement is, to put it mildly, a complicated business. Among other factors, it depends on the age at which he or she retires, where they live, and how they live. It can be affected by marital status, their health, and the markets, both before and after retirement.

And, as a recent EBRI Notes article (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”) explains, it can also be affected by the availability and source of health insurance coverage after retirement to supplement Medicare, and the rate at which health care costs increase.

Additionally, public policy that changes any of the above factors will also affect spending on health care in retirement. Consequently, trying to hit that target can feel like aiming at a bulls-eye that is not only moving, but moving fast, and zig-zagging away from the bouncing, moving vehicle in which you find yourself.

We’re often asked to come up with a single number that individuals can use to set their retirement savings goals—and while it’s certainly possible to do so (and others have), what’s often glossed over is that while that approach appears to offer clarity, a single number based on averages will be wrong for the vast majority of the population.¹ Moreover, frequently overlooked in the generalizations about retirement spending levels is the very real (and potentially huge) financial impact of post-retirement health care expenses.

Individuals will be responsible for saving for health insurance premiums and out-of-pocket expenses in retirement for a number of reasons. Medicare generally covers only about 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 13 percent. The percentage of employers offering retiree health benefits has been falling, even in the public sector, and even when offered, those benefits are becoming less generous and more expensive to the retiree.

Using a simulation model, we recently estimated the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses (excluding long-term care) in retirement. The EBRI article presents estimates for people who supplement Medicare with a combination of individual health insurance through Plan F Medigap coverage and Medicare Part D for outpatient-prescription-drug coverage. For each source of supplemental coverage, the model simulates 100,000 observations to allow for the uncertainty related to individual mortality and rates of return on assets in retirement, and computes the present value of the savings needed to cover health insurance premiums and out-of-pocket expenses in retirement at age 65. From those observations, the analysis determined asset targets for having adequate savings to cover retiree health costs 50 percent, 75 percent, and 90 percent of the time, both for individuals,² and for a stylized couple, both of whom are assumed to retire simultaneously at age 65.³

Of course, some will need more money than the amounts cited in the report, which did not factor in the savings needed to cover long-term care expenses, nor the reality that many individuals retire prior to becoming eligible for Medicare. Some will need to save less than projected if they choose to work during retirement.

Still, as hard as it can be to hit a moving target, it’s even harder to hit a target you can’t see.

- Nevin E. Adams, JD

¹ For more on the shortcomings of this approach, see “Single Best Answer.”

² Separate estimates are presented for men, women, and married couples. Because women have longer life expectancies than men, women will generally have larger expenses than men to cover health insurance premiums and health care expenses in retirement, regardless of the savings target.

³ Our analysis found a 1–2 percent reduction in needed savings among individuals with median drug use and 4-5 percent reductions in needed savings among individuals at the 90th percentile in drug use since EBRI’s 2011 analysis (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”).

Means, Tested

Recently the Center for Retirement Research at Boston College released a paper titled “Can Retirees Base Wealth Withdrawals On the IRS’ Required Minimum Distributions?”¹ The answer to that question, according to CRR, is “yes.” A more complete response might be, “yes, or any number of other random withdrawal methodologies.”

There are some advantages to a drawdown strategy based on the schedule provided by the Internal Revenue Service (IRS) for required minimum distributions, or RMDs.² First off, and as the CRR paper notes, it’s relatively straightforward. Secondly, it effectively defers initiating withdrawals until age 70-½, which also provides some additional accumulation opportunity. Perhaps most importantly, it helps avoid the stiff penalties the IRS imposes on those who don’t withdraw funds from these accounts at least as rapidly as the RMD schedule provides. The CRR paper cites as an advantage the reality that those drawdowns are based on the portfolio’s current market value, though surely some people remember how the impact of the 2008 financial crisis on those accounts triggered a more aggressive withdrawal schedule than many found optimal or necessary.

A previous post dealt with another popular drawdown method: the so-called 4 percent rule (see “Withdrawal ‘Symptoms”). As with that 4 percent “rule,” once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, those type guidelines are really “just” a mathematical exercise that involves stretching a finite pool of resources over an estimated period of time.

The CRR paper outlines a series of reasons as to why the RMD approach might be superior to alternatives such as the 4 percent rule, but ultimately the biggest shortcoming of the RMD schedule as a basis for withdrawal may be that it fails to take into account how much income is needed, much less when it is needed—and it’s based on a series of assumptions that may or may not apply to an individual’s real-life circumstance.

Of course, in a very real sense, relying on any arbitrary systematic calculation to determine how much, and how fast, to drawdown savings can be seen as a way of living within your means—an approach that can work just fine if you have first made preparations to have adequate means upon which to live.

- Nevin E. Adams, JD

¹ The CRR report is online here.

² Information about required minimum distributions is available at the IRS website, online here. IRS worksheets to calculate the amount of the RMD are online here.

For some interesting data on actual withdrawal rates from individual retirement accounts, see “Withdrawal Symptoms.”

Wealth Connected?

A recent EBRI Issue Brief (Individual Account Retirement Plans: An Analysis of the 2010 Survey of Consumer Finances) examined trends in individual account retirement plans.

Analyzing the information from the Survey of Consumer Finances (SCF)¹, it was not surprising to find that the median (midpoint) net worth of American families decreased by 38.8 percent from 2007 to 2010, and the median value of family income also decreased during that period (though at a much smaller rate of 7.7 percent).

At the same time, defined contribution retirement plan balances came to represent a larger portion of families’ total financial assets among families with these plans; 61.4 percent in 2010, compared with 58.1 percent in 2007. Defined contribution and/or IRA/Keogh balances increased their share as well, from 64.1 percent of total family financial assets in 2007 to 65.7 percent in 2010. And, while regular IRAs account for the largest percentage of IRA ownership, it is perhaps not surprising to find out, as the EBRI analysis reveals, that rollover IRAs had a larger share of assets than regular IRAs in 2010.

The Issue Brief notes, “[t]he employment-based system is generating much of this wealth from individual account retirement plans, because it includes, obviously, all of the defined contribution assets (especially from 401(k)s) as well as approximately 45 percent of IRA wealth,” as well as rollovers of lump sum distributions from defined benefit plans².

Perhaps not surprisingly, the SCF data show that participation in an employment-based retirement plan was strongly linked to family income and the family head’s educational level and race. However, in terms of net worth, families within the highest 10 percent of net worth were most likely to have a retirement plan participant in 2010, while the two net worth percentile breaks just below the highest had similar levels of participation to that of the highest net worth families. As recently as 2007, families in the lower levels of percentile of net worth were more likely to have a participant than those in the highest level.

However, the EBRI Issue Brief also looks at a comparison of the mean and median net worth across family income and age of family head shows that families with ANY type of individual account retirement plan (defined contribution plan from current or previous employer or an IRA/Keogh plan) not only have larger amounts of wealth, but that wealth is substantially larger across each and every income and age of household group (see chart below). Consider that the median household wealth for a family with annual income of less than $25,000 that had an individual account retirement plan was $118,000, while the median household wealth for a family in the same income category, but with no individual retirement account, was $5,800.

It is perhaps not surprising to find that those with more income or wealth are more likely to have an individual retirement plan account.

However, it’s surely worth noting that the data suggest that those with an individual retirement plan account – any individual retirement plan account – at even the lowest income levels, look to be much better off.

- Nevin E. Adams, JD

¹The Survey of Consumer Finances is, as its name suggests, a survey of consumer households “to provide detailed information on the finances of U.S. families.” It is conducted every three years by the Federal Reserve, and is eagerly awaited and widely used—from analysis at the Federal Reserve and other branches of government to scholarly work at the major economic research centers. The 2010 version was published in June.

²Lump-sum distributions are increasingly available in DB plans. For example, in 2010, 46 percent of full-time employees in private-sector DB plans were eligible for a lump-sum distribution (U.S. Department of Labor, 2011c). That compares with 1997 and 1995, when 76 percent and 85 percent, respectively, of full-time workers participating in a DB plan in a medium or large establishment were not offered a lump-sum distribution (U.S. Department of Labor, 1999, 1998). A recent EBRI analysis of the distribution options for more than 33,000 participants in 84 defined benefit/cash balance plans in 2010 found that only about one in five had no lump sum option. Additional information will be available in a future EBRI publication.

“Wishful” Thinking?

Last week the Wall Street Journal reported that Sears and Darden Restaurants were planning a “radical change in the way they provide health benefits to their workers,” giving employees a fixed sum of money and allowing them to choose their medical coverage and insurer from an online marketplace, or exchange1. “It’s a fundamental change,” EBRI’s director of health research, Paul Fronstin, noted in the WSJ article.

Indeed, this is the time of year when many American workers – and, by extension, most Americans – will find out the particulars of their health insurance coverage for the following year. For most, the changes are likely to be modest. And, based on the 2012 Health Confidence Survey (HCS), not only do most Americans seem to be confident in those future prospects, they would seem to be satisfied with that outcome.

More than half of those with health insurance are extremely or very satisfied with their current plans, and a third are somewhat satisfied. Nearly three-quarters say they are satisfied with the health benefits they receive now, compared with just 56 percent in 2004.

Dissatisfaction, such as there is to be found, appears to be focused primarily on cost; just 22 percent are extremely or very satisfied with the cost of their health insurance plans, and even fewer are satisfied with the costs of health care services not covered by insurance. Perhaps not surprisingly, about one-half (52 percent) of Americans with health insurance coverage report having experienced an increase in health care costs3 in the past year, though that was the lowest rate since this question was added to the survey in 2006.

The HCS found that confidence about various aspects of today’s health care system has remained fairly stable2 – and undiminished either by the passage of, or the recent Supreme Court decision on, the Patient Protection and Affordable Care Act (PPACA); more than one-half (56 percent) of respondents report being extremely or very confident that they are able to get the treatments they need, and another quarter (27 percent) report being somewhat confident. Only 16 percent of 2012 HCS respondents said they were “not too” or “not at all” confident that their employer/union would continue to offer health insurance for workers – though that was more than twice as many as expressed that level of concern in 2000.

While respondents were generally supportive of the measures broadening access and/or choice in the PPACA, nearly two-thirds said they hadn’t yet noticed any changes to their health insurance – and among the 31 percent that had, 70 percent said the changes were negative, including impacts such as higher premiums, higher copays, and reduced coverage of services.

Despite a falloff from previous surveys, more than two-thirds (69 percent) of employed workers said that benefits were “very important” in their employment decision, with health insurance topping the list of those important benefits by an enormous margin. Nearly six out of 10 said that health insurance was the most important employee benefit, as has been the case for some time now.

All of which reinforces that, while many see room for improvement in the current system, those that have employment-based health insurance now like it, and want to keep it.

It will be interesting to see if, in the months and years ahead, they get that wish.

- Nevin E. Adams, JD

More information from the 2012 Health Confidence Survey (HCS) is online here. The HCS is sponsored by EBRI and Mathew Greenwald & Associates, Inc., a Washington, DC-based market research firm, and made possible by the generous support of the HCS underwriters, listed here.

1 More information about private health insurance exchanges is available in the July 2012 EBRI Issue Brief “Private Health Insurance Exchanges and Defined Contribution Health Plans: Is It Déjà Vu All Over Again?”

2Asked to rate the health care system, survey respondents offered a diverse perspective: 17 percent rated it either “very good” or “excellent,” 28 percent consider it to be “good,” 28 percent say “fair,” and 26 percent rate it “poor.” However, the percentage of Americans rating the health care system as poor doubled between 1998 and 2004 (rising from 15 percent to 30 percent).

3Of more than passing concern is the finding that among those experiencing cost increases in their plans in the past year, nearly a third had decreased their contributions to retirement plans, while more than half have decreased their contributions to other savings as a result.