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BOSTON COLLEGE’S Center for Retirement Research just published a study that explores what Americans think are the biggest risks to their retirement—as opposed to what they objectively are. The center found “a big disconnect between how actual and perceived risks are ranked.” That disconnect could be hurting people’s retirement planning.
The study says the biggest risk to retirement is longevity—living so long that we run out of money. But the survey found that the biggest perceived threat is a market drop that cuts into savings, which the study says is—objectively speaking—only the third biggest risk.
The study’s author, Wenliang Hou, is a quantitative analyst at Fidelity Investments and a former research analyst at the Center for Retirement Research. In order of importance, these are the five biggest retirement risks, according to his study:
To evaluate the relative importance of each risk, Hou calculated the wealth required to enjoy a successful retirement, assuming objective levels of risk for each of the five categories. He then removed the various risks from his analysis one at a time. Each risk was ranked based on how much less initial retirement wealth a retiree would need if a given risk was eliminated.
Meanwhile, to gauge people’s subjective assessment of retirement risks, Hou used the University of Michigan’s Health and Retirement Study (HRS). The study is a “longitudinal panel study that surveys a representative sample of approximately 20,000 people in America.” It’s a treasure trove of data on retirees that goes back to 1992.
Consider longevity risk. Using Social Security data, Hou found that the chance of a 65-year-old man living to age 80 was 66%. But the HRS survey indicated that just 58% of those surveyed expected a man to live that long.
If we downplay the risk of longevity, we might not save enough for our later retirement years. What to do? We’d be better prepared for a long retirement if we devoted more time and effort to increasing our guaranteed lifetime income. This might be accomplished by delaying Social Security, choosing a job that has a pension or purchasing an income annuity.
Hou’s analysis also found that a second risk people generally underestimate is the chance of a health setback and the need for long-term care. He found that people’s subjective estimate for their medical spending over the next year barely changes as they age—even among Americans who are 80 and older.
One risk that people can probably cross off their worry list is the chance of a policy change hurting their retirement. For married couples, Hou measured the objective chance of a policy change upsetting their retirement success at 0.1%. Why so small? Based on past changes, Social Security reform is unlikely to have a significant impact on those already retired. By contrast, for a married couple, the objective chance of outliving their savings was calculated to be 33.4%.
Of course, analyses like this one are based on averages, so the risk assessments may not be precisely right for you or me. Still, they do provide broad guidance. In my engineering career, I would always subject an analysis like this to a “sanity check” for reasonableness. This study passes that test for me.
In my many discussions with current and future retirees, I find longevity risk is frequently underestimated. Waiting to claim Social Security, and thereby getting a larger benefit, is a smart way to address the risk of a long retirement. But the people I talk to seem to have a greater fear of dying early and “leaving money on the table.” If we delay benefits and then die early in retirement, we may shortchange ourselves when it comes to our Social Security benefit. This is the reasoning I frequently hear from folks who claim reduced benefits at age 62.
But that risk is nothing compared to the chance of outliving our money. I’ve lived that scenario with my parents. I also have friends who’ve had to help their parents financially in retirement. I’d much rather have income that’s guaranteed for life—and thereby reduce the risk of outliving my assets.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
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my immediate family was closer to a may fly than methusalah.
dad 45
mom 75
sis 55
fair/not great health for me at 64. when my wife of 29 years
died in her sleep 3 years ago, i started to cut my work/hours.
i am self employed and spending a majority of my time with a book
and a pot of coffee on the back deck with the dog rain, shine,
winter, or summer is heaven on earth. i have enuf money tucked
away to get me to 67 when i drop out all together. moving to a tiny
off grid house on a lot of land. can’t wait.
Great thoughts, Rick. My academic background was engineering, too, so I appreciate your analytical approach – makes sense to me!
I do worry about dying rich, though. We worked so hard to build our nest egg – it would be a shame to die earlier than expected while continuing to live frugally. Tricky to find a balance, I find, between enjoying what we’ve created while we can whilst planning for a long life.
Lastly, although it may not seem like a risk, I am finding as a new retiree that another source of risk to retirees is a long bull market occurring just prior to retirement. For us, this generated a big jump in our portfolio, giving us a level of confidence that we are now wondering about – did we pull the pin too early?? For me, I can safely say ‘no’ – I’m a good bit older than my wife and feeling urgency around getting busy living right now. Still, I do wonder whether there are pandemic early retirees out there who are now wondering whether they made the right choice as we watch the market decline and inflation run wild. Scary stuff!