Earlier generations of retirees often enjoyed generous pensions and retiree health benefits from their employers, in addition to seemingly secure benefits from Social Security and Medicare. Retirement is looking very different for the baby boom generation, however, as many of those supports are either disappearing or quite apparently subject to change.
Making matters worse, the recent deep recession drove down stock market and housing values, reducing the net worth of older Americans. Many of them are postponing retirement for now, but eventually — regardless of the state of the economy and their personal resources — they will retire, and some of them may have to give up thoughts of leaving bequests to the next generation. In a new book, Retirement Income: Risks and Strategies, Mark Warshawsky and colleagues suggest strategies, plan provisions, products and public policies to help middle-class American retirees, now and in the future, maximize their incomes and reduce their risks.
Based on theoretical, empirical and stochastic simulation research and surveys of retiree preferences — and with due consideration of asset allocation and withdrawal strategies — Warshawsky proposes two innovations. The first is a strategy involving a fixed-percentage withdrawal from a balanced portfolio, which is gradually used to purchase a ladder of immediate life annuities. The second proposal is a product — a life care annuity — integrating the immediate life annuity with long-term care insurance.
Life annuities and long-term care insurance are used respectively to hedge longevity and disability — two of the biggest risks facing retirees. Under a life annuity, the insured purchases a guarantee of lifetime income to be paid out in periodic, usually monthly, payments.
Someone approaching retirement with just Social Security and a 401(k) or individual retirement account wants to maximize his future flow of income while minimizing its uncertainty and maintaining some liquidity. He faces daunting risks, including volatile asset returns and interest rates, unknown longevity, uncertain inflation, and uninsured, potentially large, health and disability expenses. There are many products and strategies now being marketed to help solve this problem, with differing levels of fees.
Based on his extensive research, Warshawsky suggests that a better solution involves a period of fixed percentage withdrawals from a mixed portfolio of assets, gradually moving to a ladder of purchases of fixed immediate life annuities, while the remaining portfolio takes more risk. The extent of annuitization is dependent on the retiree's preferences and other household economic and demographic characteristics.
The integration of the life annuity with long-term care insurance resolves inefficiencies in the separate markets for both these products, according to Warshawsky. For example, empirical research shows that immediate life annuities cost up to 10% more because people with lower life expectancies do not purchase them. Some of that extra cost can be removed if those in relatively poor health who cannot purchase long-term care insurance currently because of the strict underwriting practiced by insurers instead gain access to long-term care insurance through the integrated product. The life care annuity could provide both life annuity and long-term care insurance on a favorable underwriting, pricing and tax basis.
Employers have been changing their retirement plans for some time, and the government will need to modify its retirement and health supports and policies for retirees as well. The reshaped retirement environment demands new structures and products to replace what has been lost. These products as well as public policies must recognize retirees' need and desire for flexibility and liquidity while also minimizing their longevity and disability risks.
The author believes a default offering to workers of a structured payout option — preferably including life annuities in the mix — for all retirement plan types is appropriate at the point of retirement, with due recognition that there needs to be sufficient flexibility to allow retirement plan sponsors and the market to develop new solutions, strategies and products.
Retirement Income: Risks and Strategies is available from the publisher, MIT Press, as well as from booksellers such as Amazon.com and Barnes & Noble.
Copyright 2012 Towers Watson. All rights reserved.