First Things First

This may be the time of year when thoughts turn to stockings hung by the chimney with care, but it’s also the time of year when parents have to deal with assembling some of the things in those packages. And while Santa may have elves on staff to undertake the construction of a tricycle, dollhouse or Little Tykes airplane seesaw, in our house, that "elf" was named “Dad.”

A painful lesson learned over those years was the importance of following the instructions. No matter how self-evident the process appeared at the outset, or how much I thought I remembered assembling something similar in the not-too-distant past, lurching ahead and tackling things in the order I thought made most sense was inevitably a formula for disaster. And then there was the year some miscreant had apparently “liberated” the assembly instructions from the package. Since it was Christmas Eve by the time I discovered this, all I had to go by was common sense and the picture of the finished product on the package.

Debates about the best way to achieve retirement security often seem to resemble an assembly without a set of directions — frequently without even the benefit of an agreed-upon “picture” of what the finished product is supposed to look like.

A recent hearing held by the Bipartisan Policy Commission focused on three key threats to retirement security: longevity (the risk of outliving your resources), leakage (the distribution of retirement funds prior to retirement) and the costs associated with long-term care (LTC).

Jack VanDerhei, research director for the nonpartisan Employee Benefit Research Institute (EBRI), demonstrated the impact that each of these three events can have on retirement security. With regard to leakage, he explained that more than one in five of the middle 50% who are simulated to run short of money in retirement with leakages present would have sufficient funds if leakages were completely prevented. Unlike many who tout this as a solution, however, he took pains to acknowledge that that assumed no response from participants (such as individuals deciding to contribute less (or not at all) if they knew that they wouldn’t have access to those funds prior to retirement.

Of course, once you have attained retirement, longevity risk — the risk of outliving your resources — becomes a factor. VanDerhei noted that while nearly two-thirds (62%) of the middle 50% are simulated to have sufficient retirement income, those in the longest relative longevity quartile — who would live the longest — only had a 33% chance.

One potential solution —a qualifying longevity annuity contract, or QLAC — didn’t help much. Modeling the impact of a 25% QLAC on retirement readiness, and even among those projected to live longest, VanDerhei found increases in retirement readiness of only 6.6% for early Boomers and 9.6% for Gen-Xers. Overall — that is, with no filter for longevity — this option actually reduced retirement readiness, due to the expense of these arrangements.

As for LTC expenses, while this won’t be an issue for everyone, it can have an enormous impact on the retirement security of those who are affected. VanDerhei explained that only 17% of the middle 50% of those in the top LTC quartile (those most likely to incur those expenses) will have sufficient retirement income.

Ultimately, while each of the three highlighted elements (leakage, longevity and LTC) had an impact on retirement readiness, EBRI’s numbers indicate that a bigger threat is simply not being eligible for a workplace retirement plan. How big a difference? Well, looking at the second and third income quartiles (the “middle 50%”) of Gen-Xers, the probability of not running short of money in retirement soars from 51% to 80% when you compare those with no future years of eligibility in a DC plan to those with 20 or more years.

Put another way, regardless of which solutions are put forth to deal with issues like leakage, longevity and long-term care, they’ll be of little value to those who lack access to a workplace retirement plan.

It’s not just a matter of priority — it’s all about putting the “first thing” first.

- Nevin E. Adams, JD

“Better” Pill?

As a growing number of Americans near and enter retirement, concerns about the cost of post-retirement health care expenses loom larger. In fact, worker confidence about their ability to pay for medical expenses after retirement was just half what they expressed about their ability to pay for basic retirement expenses (see EBRI’s2012 Retirement Confidence Survey).

Little wonder, since a recent EBRI Issue Brief noted that health-related expenses are not only the second-largest component in the budget of older Americans, they are the only component which steadily increases with age (see “Expenditure Patterns of Older Americans, 2001‒2009”).

Recognizing the potential financial impact, recent industry surveys have put a figure on the cost of post-retirement health care expense¹—a figure above and beyond that of merely living in retirement. EBRI has gone to great lengths to model the major risks to retirement income adequacy all the way back to the introduction of the EBRI Retirement Savings Projection Model (RSPM)® in 2003, including the incorporation of stochastic health care risks, such as nursing home and home health care costs.²

The RSPM has incorporated those expenses because, while those events will not be experienced by all retired households, or experienced to the same extent, when they do occur they can have catastrophic financial consequences for a household’s future retirement income adequacy. Many attempts to model retirement income adequacy either ignore this risk altogether, or just assume that all households purchase long-term care insurance at retirement—the former ignores a significant financial reality, while the latter glosses over reality.

Indeed, a major limitation of using income replacement rates as an accumulation target is that doing so generally fails to take into account these potentially catastrophic costs. How much difference does this make? A recently updated version of the RSPM³ shows that, with the financial impacts of long-term care (nursing home and home health care costs)modeled, 68 percent of single male Gen Xers are projected to have no financial shortfall in retirement. On the other hand, if those long-term care costs are ignored, fewer than one-in-ten would be projected to run short of funds in retirement. Similar results were found for single female and married Gen Xers.

The gaps are even more noticeable if you focus only on the situation of individuals with projected shortfalls in excess of $100,000. Ignoring long-term care costs, fewer than 1 percent of single male or married Gen Xers are projected to have shortfalls in excess of $100,000; however when you take those costs into account, approximately 18 percent of single males and 10 percent of families are now in this range, according to the model. The results are even more pronounced for single females, where ignoring those long-term care costs would indicate that fewer than 5 percent are modeled to experience shortfalls of more than $100,000, compared with approximately 34 percent when this reality is factored in.

It’s clear that those long-term care costs can be significant, and can have a dramatic impact on retirement security.

What’s less clear is why projections of retirement income needs and preparedness would continue to overlook them.

Nevin E. Adams, JD

Notes

(1) For more information, see “The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare,” EBRI Notes, August 2011, online here.

(2) The Retirement Security Projection Model® (RSPM) was developed in 2003, and in 2010 it was updated it to incorporate several significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans, and the recent crises in the financial and housing markets. EBRI has recently updated RSPM to account for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010. For more information on the RSPM, check out the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online here.

(3) More information about this update will be published in June 2012 EBRI Notes.