Seniors, you’re worried about the wrong things when it comes to retirement. You place too much emphasis on some retirement risks and not enough on others.
That’s the underlying message in a new research brief from the Center for Retirement Research at Boston College authored by Wenliang Hou, a quantitative analyst at Fidelity Investments and a former research economist at the Center.
The brief, titled “How Well Do Retirees Assess the Risks They Face in Retirement?” finds that retirees do not have an accurate understanding of their true retirement risks, and there’s a large disconnect between how actual and perceived risks are ranked.
The analysis finds actual risks should be ranked as such: 1) longevity; 2) health; and 3) market. But perceived risks are ranked: 1) market; 2) longevity; and 3) health.
Specifically, Americans ages 50 and older are about three times as worried about market risk as Hou’s modeling suggests that they should be, 50% less worried about their own longevity risk than they should be, and 30% less worried about healthcare costs in retirement than they should be.
“In short, retirees overestimate market volatility and underestimate how long they will live and their health costs,” a summary of the brief states.
Perceived longevity risk and health risk rank lower, because retirees are pessimistic about their survival probabilities and often underestimate their health costs in late life, Hou writes in the brief.
Retirees face numerous risks in retirement, including outliving their money (longevity risk), investment losses (market risk), unexpected health expenses (health risk), the unforeseen needs of family members (family risk), and even retirement benefit cuts (policy risk). (SEE “The 5 Major Risks in Retirement” BELOW).
The brief explores how important these risks actually are, and whether Americans properly perceive these risks when making their consumption and investment decisions. To answer these questions, the brief systematically values and ranks the impacts of these various risks from both the objective and subjective perspectives.
The analysis, which uses data from an earlier research paper (the Health and Retirement Study), involves constructing a lifecycle optimization model to quantify each risk by estimating how much wealth retirees are willing to give up to insure against it.
In summary, Hou finds the implications of the analysis are threefold:
“First, retirees do not have an accurate understanding of their true retirement risks. This finding highlights the importance of educating the public on the most significant sources of risk. Second, this analysis confirms the importance of longevity and market risk, underscoring the need for lifetime income either through Social Security or private sector annuities. Finally, long-term care is also a significant risk faced by retirees, but one they often underestimate. Better designed public programs and private products, possibly integrated with life annuities, could be encouraged to protect retirees with limited financial resources from this potentially catastrophic risk.”
The 5 Major Risks in Retirement
As included in the research brief, the five major risks identified in recent studies are:
- Longevity Risk: The risk of living longer than expected and exhausting one’s resources.
- Market Risk: Since most people now save through 401k plans, retirees face the risk associated with market volatility. They also face risks in the housing market, because few downsize after retirement.
- Health Risk: Retirees also may have unexpected medical expenses and long-term care needs. Out-of-pocket expenses rise quickly with age, and health costs in retirement have increased substantially over the past few decades.
- Family Risk: This risk, which has received increasing attention, includes divorce, death of a spouse, and adult children becoming ill or unemployed. This risk might be harder to manage than the longevity, market, and health risks because it could have an effect over a longer period of time.
- Policy Risk: Social Security is the primary income source for most retirees, and the program’s trust fund reserves are projected to be depleted in 2035. Therefore, without any policy changes, everyone would experience a 20- to 25-percent benefit reduction after that point.
SEE ALSO:
• Americans Dangerously Out of Touch with Retirement Healthcare Costs
• Market, Longevity Risk Are Top Concerns for American Workers
• Majority Doubt They Will Receive Promised Social Security
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
