Baby boomers seem to be overestimating how long their
retirement savings will last — or maybe underestimating how long they’ll live.
New research from the Center for Retirement Research at Boston College found
that Boomers may be drawing down their retirement wealth faster than previous
generations, because they lack the widespread access to pensions that older
generations enjoyed. Using data from the University of Michigan’s Health and
Retirement Study, CRR researchers determined the more annuitized resources
retirees have at their disposal, the slower they draw down their wealth. A
financial advisor can help you calculate how much retirement savings and income
you’ll need once you stop working.
Baby Boomers Face Increased Longevity Risk
Boomers stand to draw down on their retirement savings
faster because of their reliance on defined contribution plans.
Baby Boomers, the generation of Americans born between 1946
and 1964, were subject to a “massive shift” in retirement planning, as
employers transitioned from defined benefit plans to defined contribution
plans. While defined benefit (DB) or pension plans provide beneficiaries with a
guaranteed income stream, defined contribution plans like 401(k)s are typically
much cheaper and less complicated from the employer’s standpoint — but they
don’t give employees as secure of a future.
As a result, people born after 1960 have had limited access
to pension plans, whose availability has dropped precipitously since 401(k)s
were introduced. Using data from the Health and Retirement Study, CRR
researchers found that a majority of households with heads born between 1920
and 1940 had access to a DB plan.
“Retirees with a DB had less need to draw down financial
assets in their retirement accounts to cover their spending and could reserve
these assets for late-life medical expenses or bequests,” CRR’s Robert
Siliciano and Gal Wettstein wrote.
Without the guaranteed income stream that a pension
provides, baby boomers may run a higher risk of outliving their retirement
savings, known as longevity risk. In fact, Siliciano and Wettstein compared the
drawdown speed of retirees, both with and without access to DB plans, at age
70, 75 and 80. At all three ages, retirees with DB plans had slower drawdown
The researchers found that retirees with $200,000 in
starting wealth and access to a DB plan have $28,000 more in assets by age 70
than their counterparts. “By age 75 and by age 80, the household with a DB plan
has drawn down 36 log points less of their initial wealth, corresponding to
$86,000 more wealth,” Siliciano and Wettstein wrote.
The researchers concluded that baby boomers who base their
forecasts on the drawdown speeds of past generations “likely underestimate” the
speed at which they’ll go through their retirement savings.
How to Stretch Your Retirement Savings
Siliciano and Wettstein point out early in their paper that
retirees with larger proportions of annuitized wealth drew down their wealth at
slower rates than others. While annuitized resources include the types of DB
plans that are far less common now Social Security and commercial annuities also
fit the bill.
Workers without pensions who are approaching retirement may
consider delaying Social Security as long as possible to maximize their
eventual benefits and inflate the only guaranteed income stream they have. To
maximize your benefits, you’ll need to work for at least 35 years and reach
full retirement age (67 for people born after 1960). If you choose to delay
claiming Social Security beyond your full retirement age, you’ll boost your
eventual benefit even more.
Commercial annuities can also replace the guaranteed income
that pension plans would have provided, making them popular investments for
some. These financial contracts enable you to exchange a lump sum or periodic
payments for a future income stream. However, you’ll run the risk of not
breaking even if you don’t live long enough. High fees and contract limitations
can also serve as deterrents.
Lastly, retirees looking to ensure their savings won’t run
out will need to carefully plan how much is safe to withdraw each year. Perhaps
retirement’s most quoted rule of thumb dictates that if you withdraw 4% of your
savings during your first year of retirement and then adjust your withdrawals
for inflation each subsequent year, those savings should last 30 years.
However, if your first year of retirement corresponds with a market downtown,
your portfolio will be worth less than it would be otherwise. Known as sequence
of returns risk, withdrawing money during a market downtown means your returns
will shrink and the size of your nest egg will diminish faster.
It’s important to remain flexible and be able to adjust your
withdrawal rate during market volatility. Having cash on hand can also help you
avoid withdrawing too much from your portfolio when stock prices fall.
Since baby boomers have had less access to traditional
pension plans, they are at higher risk of drawing down their retirement savings
faster than previous generations, whose workers typically had pensions.
Delaying Social Security, investing in an annuity and maintaining a flexible withdrawal
rate can help mitigate this drawdown risk.
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