Future Retirees Will Be More Vulnerable to Market Shocks: CRR

Replacement rates for the wealthiest Gen Xers and trailing boomers at age 67 are down 21% and 18%, respectively, according to projections from Social Security's Office of Retirement Policy. For middle-income and lower-income Gen-Xers and trailing boomers, the expected replacement rates are down about 9% and 6%, respectively.

Moreover, these replacement projections may understate the actual deficits because "they assume that households annuitize most of their savings at an actuarially fair rate … but very few retirees annuitize and even those who do cannot get actuarially fair rates," the report notes.

This growing dependence on financial assets and reduced income replacement projections have implications for future retirees and their advisors:

• They increase the importance of asset allocation and drawdown percentages from retirement savings. "Whatever the safe withdrawal rate and asset allocation, the risk of running out of money rises if retirees draw out more or invest a different amount in equities," the report notes. It adds that the traditional 4% drawdown rule may be "too high given rising longevity and potential declines in investment returns."
• They also means more retirees may have to trim spending so that they don't outlive their savings. The typical elderly household uses 80% of its expenditures for housing, health care, food, clothing and transportation, but a big financial shock such as a sudden increase in health care costs or loss of income when their spouse dies could easily leave them with insufficient funds to cover basic expenses. Women widowed between 2002 and 2004 typically received 62% of a couple's Social Security benefit and only half an employer's pension benefit when they need 79% of a couple's income to maintain their standard of living, based on federal poverty thresholds, according to another study cited in the report.

"The most effective response for households approaching retirement is to increase their retirement income and reduce their fixed expenses," the CRR preport concludes. It suggests that those future retirees work longer, annuitize wealth and take out a reverse mortgage to increase their retirement income and downsize to reduce fixed expenses and increase financial assets. "Whether the prospect of increased financial fragility leads them to change their behavior remains to be seen."

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