A recent article in SmartMoney highlights a topic that has been front and center for financial planners for awhile now - the fact that retirement is changing, and funding retirement is a dicier proposition than it used to be.
The article is titled 4 Reasons Your Retirement Is Riskier Than Your Parents’. It is based on a National Retirement Risk Index that has been developed by the Center for Retirement Research at Boston College. In this case, "risk" is defined as the likelihood that we'll be able to maintain our standard of living beyond the age of 65, and the concerns outlined pertain to both Baby Boomers and Gen Xers. The trend identified in the study clearly leans toward less and less preparedness the farther we are from retirement. In other words, Boomers are not very well prepared compared to their parents, but we Gen Xers have it worse than the Boomers.
The drivers behind the heightened uncertainty are grouped into four trends:
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We're living longer. Of course, this would be less of an issue if we're also working longer, and I suspect that will be a new development as we progress, but right now the study shows the average retirement age at 64 for men, and 63 for women.
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Replacement rates are falling. In this case, replacement rate refers to the percentage of income that is replaced by retirement benefits. As we move forward, the amount of Social Security that we'll receive is decreasing. Furthermore, although the article points out that the share of the workforce that is covered by an employer plan has remained steady, the nature and amount of that coverage has changed. Defined benefit plans, in which a retiree received a fixed percentage of salary, are increasingly rare. Defined-contribution plans, such as a 401(k), in which employees contribute to prepare for retirements, are now the norm. This puts more burden on individual employees to save an appropriate amount and to invest it prudently. That may not be an outrageous expectation, but it's not happening. As the article points out, the median balance for heads of households entering retirement is only $78,000. That is not going to go very far, especially as Social Security coverage decreases.
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Retiree-paid health costs are rising. This subject is a bit harder to predict, as we await the longevity and full implementation of Obamacare. However, it's hard to imagine the government picking up more of the tab for the same level of care, given the current underfunding for entitlement programs. It's possible that we'll somehow see a reduction in the inflation rate of health care costs, but that has not been the trend and it's probably not a solid assumption to make when planning for retirement.
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Returns have declined. This is perhaps the shakiest point in the article. It is true as stated: asset returns generally have declined over the past two decades, and bond yields are certainly well below average. However, to a certain degree recent declines have helped to ensure that future growth will be stronger. I think a more valid point is that we've seen the effect that reverting to average long-term returns can have, and it pays to be conservative when making assumptions about future asset growth for the sake of retirement planning.