New analysis from the Society of Actuaries suggests the traditional scope of retirement planning is not adequately accounting for the frequency of financial shocks retirees experience after they leave the workforce.
The new data is an extension of SOA’s biannual Risks and Process of Retirement Survey, most recently conducted in 2015.
According to the recent findings, more than one in three retirees who experienced a financial shock saw the value of their total assets decline by 25 percent or more, according to the SOA.
And more than 20 percent said financial shocks resulted in a 50 percent or more depreciation of their assets.
For 14 percent of the respondents, financial shocks resulted in deleting most, or all of their assets.
New angle on assessing retiree risk
The influential Society of Actuaries, the world’s largest actuarial organization that sets the mortality tables used by the Social Security Administration, IRS, and private pension managers to factor longevity risk in benefit and pension management, has for years examined the assumptions retirees use to prepare for life after work.
The Risks and Processes Survey has traditionally focused on the experience of recent retirees.
The focus groups the Society conducted around 2013’s report showed that those new to retirement had a limited focus on their retirement needs, said Anna Rappaport, a fellow at SOA and Chair of the oversight group that publishes the Risks and Processes Survey.
“We were finding that recent retirees talked about financial planning in terms of short term expenses—whether or not they could cover month-to-month bills,” said Rappaport in an interview.
“When it came to the prospect of unexpected financial shocks, new retirees had a ‘we’ll take care of it when it happens’ approach to planning,” she said.
That perspective raised the curiosity of SOAs actuaries. So for the most recent data set, they decided to focus on the experiences of those that have been retired at least 15 years.
What SOA found is that for many retirees, expenses are higher than expected when they first enter retirement. The incidence of financial shocks account for much of the discrepancy, says Rappaport, an actuary who spent nearly three decades consulting on pension management with Mercer.
The new data shows nearly 20 percent of all retirees, and about a quarter of retired widows, report having experienced four or more financial shocks, while only 28 percent of surveyed retirees say they have yet to incur unforeseen expenses.
The source of those financial shocks came as some surprise to Rappaport and her team. Going in to the project, the actuaries presumed out-of-pocket medical expenses would account for the largest financial shocks.
To the actuaries’ surprise, that factor was relatively benign. “We thought unexpected health costs would be the leading source of shock, but most of the respondents reported having supplemental insurance to Medicare—there wasn’t a lot of complaining about the shock of health care costs. It wasn’t the problem we thought it would be.”
Instead, the primary culprit of financial shock for those well into retirement was home repair costs—28 percent experienced major home repairs they hadn’t accounted for in their planning.
The second largest source of financial shock came from dental expenses, which are not covered in Medicare: about a quarter reported financial setback from dental costs.
Rappaport says the new data shows that there are three sources of financial shock that were particularly challenging for retirees: the cost of prolonged long-term care, divorce in retirement, and need for retirees to assist with their children’s financial needs.
“We found people really struggled managing these three specific expenses,” said Rappaport.
Not doing what advisors would say they should
On balance, retirees showed resiliency in managing unexpected costs.
Of the retirees that report having incurred a financial shock, three in four said they were able to manage adequately under the financial constraints.
But for some retirees, major life-style adjustments were required. One in 10 said they had to reduce spending by 50 percent or more to survive the shocks.
The unexpected death of a spouse was also an area many respondents were inadequately prepared for, as some respondents reported consequent reductions in Social Security and pensions. Of the widows in the survey, only 34 percent said they considered the unexpected death of their spouse in planning for retirement; one in three widows reported giving no consideration to the impact of spouses’ deaths on retirement income.
Rappaport said two themes prevailed from measuring the experiences of those with some time under their belt in retirement.
“You can’t limit retirement planning to what your situation will be on the day you retire,” she said. “You have to think in longer terms.”
“And the other thing I think we really learned is that people are not doing what a good advisor would say they should do,” she added.
All told, about two-fifths of retirees said their retirement expenses were greater than they had planned for—for widows the number was higher, at 44 percent. Only 12 percent of retirees said their expenses were lower than anticipated.
When it comes to how much retirees can spend on unexpected costs, experiences varied widely relative to their income.
About 30 percent of retirees said they could spend at least $25,000 on an unexpected cost without jeopardizing their retirement security.
Others are clearly not as fortunate. One in five retirees said they had less than $1,000 for emergency expenses; another 10 percent could spend less than $5,000; and 10 percent could spend less than $10,000.
“When a retiree’s security is compromised by a $1,000 expense—that is clearly troublesome,” said Rappaport.
The potential strategies for preparing for financial shocks in retirement are manifold, noted Rappaport, who said the SOA is planning new work on income replacement rates to address the issues raised in the recent report.
“The best answer is long-term planning with respect to each individual situation,” she said. “These are not easy issues. Cash flow cannot always be predicted, and planning for unknown costs is an inherently complicated question.”