12 November 2018

Americas Retirement Spending Problem

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There is ample disagreement about whether Americans are sufficient savers. Some researchers find that American retirement saving is woefully inadequate: the Boston College Center for Retirement Research estimates that in 2010, 53% were on a path to having insufficient assets to comfortably retire at age 65 and puts the total under-saving gap as high as $14 trillion. But this evidence contrasts sharply with some academic studies by prominent economists who found that the share of under-savers was just 15.6 percent in 1992 and had only risen to 25.9 percent by 2004, with small average deficiencies among inadequate savers.

The ongoing debate about Americans' saving behavior during their working years, however, misses the equally important question of whether retirees will spend their nest egg in the right way. For millions of older Americans, securing a sound retirement means both accumulating wealth while working and, importantly, transforming that wealth into lifetime security through vehicles such as annuities, long-term care insurance, and even reverse mortgages.

Insurance markets are important for some retirees, but not all. For example, Social Security and Medicare are often sufficient, or nearly sufficient, to enable workers with low lifetime earnings to achieve a standard of living in retirement that comes close to matching their pre-retirement income. On the other end of the spectrum, workers with high lifetime incomes can often "self insure" by effectively over-saving during their working years then bequeathing any unspent wealth to their heirs at death.

For everyone else, markets for insurance-like products can be a critical tool for achieving retirement security. Without these markets, households either under-save and hence risk retirement security or over-save to protect against various retirement risks-not the least of which is living longer than expected-and consequently enjoy less consumption and happiness over the course of a lifetime. The problem for many retirees is that they simply don't have access to or knowledge of insurance products that can help to provide security.

Annuities are frequently eschewed by American households, with fixed annuity contracts amounting to just over 1 percent of retirement account wealth among 66 year olds in 2008. There are lots of reasons-collectively referred to as the "retirement puzzle"-for why workers on the cusp of retirement don't purchase these products. Low-interest rates are one key factor; another important barrier is the high potential for soaring out-of-pocket health spending. 

 Long-term care risk is a very real threat to older Americans, but few households carry private insurance. In recent years, only one-in-ten elderly people carried long-term care insurance, and the annual growth rate of new premiums has been stagnant for at least a decade. One notable concern with long-term care insurance is the low expected benefit relative to the cost.

Lastly, reverse mortgages potentially offer seniors a vehicle for turning housing equity into cash without forfeiting a spot in their homes. While reverse mortgages showed signs of life through the Home Equity Conversion Mortgage program, which originated 400,000 reverse mortgages between the inception of the program in 1989 and 2007, the market remains plagued by reports of improper lending behavior and misunderstanding among borrowers

The Treasury Department released a smart set of regulations last month that would make it easier for savers to purchase longevity annuities - annuities that feature a gap between purchase and onset of benefits - in their retirement accounts by relaxing rules on minimum distribution requirements. In 2013, Congress passed a reverse mortgage reform bill that would provide elderly borrowers with better protections and more education.

Americans are not perfect savers, but retirement security requires much more than just a high personal saving rate. Contrary to public sentiment, America has a retirement spending problem, not just a saving one.

Click here to access the full article on Brookings Institution.

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