Americans are starting to live a lot longer than they ever thought they would, throwing a wrench in retirement fund plans that they thought would last them the rest of their life.
That is just one challenge facing the 77 million Baby Boomers, and as they begin to retire, they will need to structure their retirement portfolio in a way that mitigates not just the risk of inflation and the market, but also mortality, by recognizing what products will work best for them in retirement, according to a report from the Fidelity Research Institute, "Structuring Income for Retirement."
Regarding mortality, a female today who is 65 has a 56% chance of living until 85 and a 35% chance of living to 90, and for men, it's 46% and 24%, respectively.
People base their life expectancy on family history but don't factor in medical advancements that help people live longer, said Mathew Greenwald, president of research and consulting firm Greenwald & Associates of Washington.
"People are not reading academic studies to anticipate how long they are going to live," agreed David Wray, president of the Profit Sharing/401(k) Council of America in Chicago.
Additionally, it's very difficult for people to plan for the future, Greenwald said. Most people are focused on the here and now, he said.
Investors need to experience knowing someone or hearing stories of regular people living in retirement and running out of money to really impact the way they save for retirement, experts said.
This is not an environment that existed 40 years ago, as in the past people had defined benefit plans and Social Security was not in question, Wray said. It's going to take a couple of generations to transition to people adequately saving enough money for retirement, he noted.
However, there are steps that people can take to start saving more money and planning. People need to make consumption decisions, especially as they grow older, said Joseph Birkofer, a financial adviser and principal with Houston-based Legacy Asset Management.
People assume that expenses will go down in retirement, but that is often not the case and prescription drugs can be very expensive, Greenwald said.
Also, people need to start saving more money at a young age. The reward for early thrift is magnified when people live for a very long time, Wray said. However, thrift is not a principal cultural trait of America, he quipped.
Retirement needs are very different from one person to the next. It is important to look for income solutions and then choose one that makes the most sense personally, Wray said. Many programs provide for a great deal of flexibility, he said.
How a retiree's portfolio is set up is very important. The risk management challenge for retirees is to structure their investment assets and income products in such a way as to reach a personally optimal retirement income solution, according to Fidelity.
Fidelity's report analyzes three basic products for investors to possibly use: a lifetime income annuity with fixed or variable payments, a variable annuity with guaranteed living income benefits for life, and a traditional systematic withdrawal plan with investments in stocks, bonds and cash. Each one has a different role in a portfolio and different costs and tradeoffs for the investor.
Regarding longevity insurance or guaranteed income, it is not beneficial for every investor. If a retiree is confident that they will be able to meet their needs with low withdrawal rates from their assets, buying added longevity insurance probably doesn't make much sense, the report states.
However, it is helpful for retirees with moderate savings and relatively high withdrawal rates as it can notably increase the sustainability of their retirement incomes by purchasing guaranteed income products and sacrificing potential legacy amounts.
There is a shift towards guaranteed income products, Birkofer commented, stating he is starting to explore them for some of his clients, but the products are still in their infancy. One problem of the guaranteed income is the cost of creating the product is far more expensive then one realizes, he said.
"Currently, the trade-offs presented by many guaranteed income products are too complex, and the deterrent to purchase is exacerbated by the perception that these are irreversible decisions," said Van Harlow, managing director of the Fidelity Research Institute.
"Until the importance of guaranteed income is more effectively communicated and its benefits to specific financial situations clearly demonstrated, investors' willingness to consider or purchase them will increase only at a measured pace," he said.
Firms also need to step up to the plate and offer more solutions. "Integrating longevity/mortality risk with investment and asset allocation risks and then creating truly optimal solutions is arguably the most important thought frontier for financial services in America," Fidelity states.
There are new products coming out all the time for retirees and it is important that firms familiarize themselves with them, Greenwald said.
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