People are likely to under-estimate how long they will live in retirement and likely to over-estimate market volatility. Image: Vlyaks/Shutterstock.com
By: FEDweek StaffMuch of retirement preparation focuses on what the individual hopes for in retirement. Common desires include more travel, spending more time with family and friends, relief from the daily grind of work, ability to pursue interests, or changing one’s line of work for example by turning a hobby into a business.
Such desires commonly drive financial planning for the retirement years, especially for the earlier stages when people to be more active before expecting to cut back as they age.
But what about the flip side? What do you consider to be the main risks of retirement?
A recent report from the Center for Retirement Research looked into five types of retirement risk that commonly are cited in studies of retirement. In alphabetical order:
Family risk—the risk of family members’ needs acting as a drain on retirement savings
Health risk—the risk of unexpectedly high medical expenses
Longevity risk—the risk of outliving one’s retirement savings
Market risk—the risk of high volatility/losses in retirement savings
Policy risk—the risk of policy changes that will result in decreased benefits
Take a moment and rank them in order from one to five as risks to you.
[“Jeopardy” theme plays]
The study said that retirees subjectively consider the top three risks to be market risk, health risk and longevity risk in that order. However, it concluded that in reality the top three are longevity risk, health risk and market risk in that order. In both cases, family and policy risks ranked far below the top three.
The main reasons for the difference, it said, are that people are likely to under-estimate how long they will live in retirement and likely to over-estimate market volatility. In other words, people overall are too pessimistic about both.
On the former, it cited a study in which people age 65-69 were asked to estimate their probability of living to age 80. Only 58 percent of men and 64 percent of women had that expectation, where according to actuarial tables a man has a 66 percent chance at age 65 and a 70 percent chance at age 69, while for women the figures are 75 and 78 percent. (The percentages are higher at the older ages because by then people already have lived through four years in which they could have died.)
Similarly, it said, in studies about people’s views about the stock market, “individuals’ expectations about volatility are much larger than the volatility of actual returns.”
Those two work together to drive people’s assessments of risk, it added, because a shorter expected life span “intensifies the market risk expectation because of a shorter investment horizon.”
Regarding health-related costs, it cited data showing that people’s expectations of certain levels of medical spending in the next year–$8,000 or more, $3,000-$8,000 or $1,500-$3,000–are largely consistent across age groups in five-year increments starting at age 65 through age 85. That suggests that “older people underestimate medical spending and younger people overestimate it.”
Said the report, “retirees’ misunderstanding of the importance of various retirement risks highlights the need for more education and provides unique insight into the need for lifetime income, either through Social Security or annuities, which hedge both longevity and market risks.”
The good news for current and retired federal employees is that they do have annuities that provide lifetime income—a lesser one for those under FERS than under CSRS, although FERS also includes Social Security where CSRS doesn’t—which provide a hedge.
Is that enough for your retirement? In many cases no, which is where the importance of saving and wise investing through the TSP during one’s working years comes in. And also the importance of wise decision making regarding continued investing and withdrawals after retirement.
Meanwhile, one of the main drivers of the two top risks, longevity risk and health expense risk, is long-term care, whose costs retirees “often underestimate,” the report said—and against which only low percentages of federal employees and retirees take out insurance.
Along with your desires, shouldn’t your retirement planning also take risk into account?
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See also,
House Republicans Revive Retirement Benefit-Cutting Proposals
Installments vs. Annuity: Using Your TSP for Regular Income
The Process of Retiring – Making Late Changes
Retiring from a Federal Job – Getting Started
Retiring from a Federal Job: Make Sure Your Agency Gets it Right
Nine Hours on Hold: Pressure Builds on TSP to Improve Customer Service
