Many of us can recall stories of parents and grandparents who spent 40-year careers working for a phone company or bank and retiring at age 60 with a defined benefit (DB) pension that supported them in their retirement with a monthly check for the rest of their lives. This predictable stream of retirement income, combined with Social Security or other personal savings or earnings, simplified planning for those who retired a generation ago, when the average lifespan was in the mid-70s.
Today, there are two major factors that have caused many more workers to lose that retirement security.
First, employers have shifted from DB plans to defined contribution (DC) plans (e.g., a 401(k)), with just 2% of private sector workers enrolled in DB plans today, according to the Employee Benefit Research Institute. Unlike DB plans, DC plans require workers to assume all the responsibilities for deciding whether and how much to save without any predictable stream of income at retirement.
And, second, we are living much longer, making it necessary for retirement savings to last longer than ever before. According to the U.S. Social Security Administration, a man turning 65 today can expect to live, on average, until age 84, with one-quarter of those turning 65 today expected to live until age 90 and 10% projected to live past age 95.
The problem with relying on a DC plan as a core or primary retirement plan is that it was never designed to provide retirement security. Such plans were originally intended as tax-advantaged supplemental retirement savings plans that would enhance benefits already provided by traditional DB plans. Today’s core DC plans are primarily focused on wealth accumulation and preservation but fail to offer workers options to help them manage their incomes to last a lifetime.
Longer lifespans require revisiting lifetime income strategies
The World Economic Forum (WEF) recently issued a report “We’ll Live to 100 – How Can We Afford it?” This report title succinctly captures the demographic and economic challenges for future generations of retirees. On average today’s 20-year-olds are projected to live to be 100 and today’s 10-year-olds are expected to live to be 103. According to TIAA, more than 800,000 Americans aged 65 or older retired in the last quarter of 2016, 10,000 baby boomers retire each day, and the number of retirees is expected to grow by 60% between 2014 and 2040. Life expectancy has steadily increased during the past century.
These are significant challenges that will require new thinking about retirement planning. How closely does living longer align with the realities of aging, workforce participation, and lifetime earnings? Is it possible to have sufficient income in retirement if you are working, at most, 45 years out of those 100 years? For policy makers, it’s time to consider what an increasingly older population means for the sustainability of our retirement system. This must include the consideration of lifetime income strategies in today’s DC plans.
Retirement security is more than your 401(k) balance
Your retirement savings account balance is only one of many factors that determines if you will save enough to meet your needs in retirement. Age, lifestyle, health, and cost of living all play a role. Yet, the focus of today’s core DC plan has been wealth accumulation and preservation. This is appropriate for a supplemental savings plans, but not for what DC plans have become, which is the primary vehicle for retirement savings. The goal of wealth accumulation only makes sense when the funds are intended to pay for what you want in retirement after your basic needs are met.
If the goal of a retirement plan is to generate enough income in retirement to maintain a certain standard of living, or at least meet basic needs in retirement, retirement savings plans should address the risk that someone may not replace an adequate percentage of preretirement income. If retirement security is the goal, how much you have saved is less important than how much income you can generate from those assets in retirement.
Effectively managing income in retirement is critical
Unfortunately, many people don’t realize early enough how much money they need for retirement. They underestimate how much annual income is necessary, or fail to consider common but unexpected health care or family expenses that seriously impact what retirement looks like. A recent MetLife study found that 20% of retirees taking a lump sum spent all of their retirement savings in just 5-1/2 years. Others struggle with transitioning from saving to spending and end up living a lower quality of life than necessary because they are not comfortable spending the money they have saved. Detailed planning and regular reviews are critical to maintaining that necessary balance during retirement.
Expanded options for lifetime income are needed
To provide retirement security, employers need to offer options other than lump-sum distributions when a worker retires. While financial education initiatives can have a positive impact on participant savings rates, it may not be enough. It is unrealistic to expect people to learn and apply the evolving, nuanced financial expertise required to know how to manage their money through their retirement to last a lifetime.
Most large employees still do not offer, and are not likely to offer, options that help those saving for retirement convert their savings plan account balances into lifetime income, according to a recent survey by Aon Hewitt. Changing behaviors, such as how today’s younger workers change jobs more frequently than their parents and grandparents, underscore the need for reframing how we structure ways to save for retirement.
In 2016, the U.S. Government Accountability Office (GAO) recommended that the U.S. Department of Labor (DOL) provide more effective guidance about lifetime income options to encourage policy makers and retirement plan sponsors to focus on retirement security. The DOL acknowledges that lifetime income is an important public policy issue. And Congress recently introduced a proposal to reduce regulatory burdens and help encourage more employers to offer lifetime income solutions in their retirement plans.
The easier policy makers make it for retirement plan sponsors to offer effective income distribution strategies, such as lifetime income solutions and/or structured withdrawal options, the more time and resources the financial industry will commit to developing new solutions. This is an important step in achieving widespread adoption by employers, and ultimately, improving retirement security for recent and future retirees.