I want you to think for a moment and answer the following question honestly. After you read the title, was the first thing that went through your mind — or maybe the second thing — the following lyric? “Ah, ha, ha, ha, stayin' alive, stayin' alive.” It’s a refrain that is etched into Americana, and one that everyone, across generations, knows.
What does that song have to do with retirement income? Almost nothing — it was just a catchy hook to try to engage you in a discussion about retirement income. But it does touch on an important point: People are living longer, expected levels of return for key drivers of portfolio total return are lower and sequence of return risk is the villain that can ruin retirement lifestyle. The refrain is a playful reference to increased longevity but those three issues, and what we as an industry can do about them, are serious topics.
“We can try to understand”
The American Express Company was the first in the U.S. to create a private pension or “defined benefit’ (DB) plan.”1 These plans offered employers the ability to compete for talent, and created an incentive for employees to remain with those employers for extended periods of time. The Revenue Act of 1978 was the basis upon which defined contribution (DC) plans were built, because it provided a mechanism for tax-advantaged savings for retirement.2 This did two things:
- First, it allowed workers to change jobs more freely, increasing worker mobility.
- Second, it shifted responsibility for managing longevity risk onto the participant. DB plans centralized management and pooled individual risks, placing retirement security risks on the plan. DC plans fundamentally place the responsibility for ensuring retirement security squarely on the shoulders of participants. These individuals must decide on a contribution rate and asset allocation, then maintain a degree of investment discipline that even challenges trained professionals. Finally, while in retirement, the decision on how much to spend and how to invest are key determinants in whether someone will outlive their assets or maintain their desired quality of life.
While some may be planning on Social Security income as a core component of their annual retirement spending, concerns about the long-term viability of the program in its current form mean younger workers could face a scenario where the only income available to them is drawn from their accumulated savings.
According to data from the World Bank and Center for Disease Control, over the last 50 years, life expectancy has increased by nearly 10 years with approximately half of that occurring over the last 25 years.3 This is an important consideration. Why? Two reasons:
- First, as access to healthcare and the quality of treatments and outcomes across a range of ailments improve, we should see life expectancy continue to increase.
- Second, if you are the average 55- to 64 year-old with $408,000 in retirement savings and $130,000 in pre-tax family income4 then, assuming that the next 20 years are like the last, the prospect of maintaining your targeted lifestyle for an additional three to five years could be a challenge.
“I get low and I get high”
Mr. Market is a key contributor to retirement outcomes. His mood year-to-year dictates equity returns. Over time, we know that equities have had a positive risk premium. However, in any given year Mr. Market can feel good and move higher, or feel bad and move lower. In considering retirement accumulation and decumulation (accum/decum) planning, when it comes to the decum part of the equation, i.e. retirement spending, a bad year early in retirement can have a significant impact on quality of life over time. This is risk related to the sequence of realized returns. This risk has some important implications. Fundamentally, a retiree faces two key choices: how much to spend and how to invest. The two are inextricably linked. Spend too little, and you don’t have the quality of life you might have otherwise had if you had spent more. Spend too much and you start strong but may not be able to sustain a desired standard of living. Add in the dynamics of Mr. Market and sequence of return risk, and the questions of how much to spend and how to invest present daunting challenges for the average American.
The problem is one that has complexity along two dimensions: its ambiguity and its underlying dynamics. By ambiguity, I mean the probability of success is unknown. We try to estimate it with Monte Carlo simulations that project thousands of potential outcomes and other mathematical tools as best we can. The second problem is related to the first. The probabilities are estimated using a collection of potential future paths, but the path the investor experiences is a single, actual one, not an average of multiple possibilities. Simply put, where you end up depends on the choices you make leading up to that point. The choices you make depend on where you think you’ll end up. It’s an interesting set of problems that even experts debate about. What can a retiree do to address their concerns?
“Somebody help me, yeah”
I can recall sitting in a hotel room in Mexico on my honeymoon the day that Lehman Brothers failed and Bank of America bought Merrill Lynch. The events that followed and the stories of retirement ruin that I heard from personal friends or that the media shared had an indelible impact on me.
The risk of shortfall in retirement is an unavoidable one. For someone who is retiring and trying to plan their future, what is peace of mind worth? That answer probably depends on the person. Fortunately, we have well-developed markets for risk transfer in the U.S. so we can determine a price for peace of mind conditioned upon a person’s level of comfort with uncertainty and longevity risk. We also have an innovative asset management industry that continues to develop solutions in an effort to address this risk. For example, since 2009, SEI has offered retirement income strategies with varying payout targets. They are potential alternatives to an annuity for fee-conscious clients that may be okay with carrying some degree of longevity risk since the payouts are not guaranteed.
Some clients might prefer to guarantee their income in retirement, and may be willing to pay the fee associated with that “peace of mind.” Others may want to think about a mixture of certainty as it relates to food, shelter and other needs while accepting a higher level of uncertainty when it comes to wants like travel, a second home, etc. Whatever the case may be, as an industry we can continue to push the envelope, developing solutions that help address these needs in an effort to give individual investors more peace of mind and an improved quality of life throughout retirement.
If you actually read through the lyrics of the song “Stayin’ Alive,” they are a bit depressing. That said, the lines that stand out along with the memorable refrain are references that resonate when you think about the dimensions of the retirement savings (and spending) challenge. I don’t know if late 70s hairstyles and Bee Gees music will make the same resurgence 1980s “mom jeans” have, but I do hope that, as an industry, we can provide individual investors and their advisors with the solutions that help them recreate the late 70s DB experience. By doing so, we can help advisors and their clients build, and secure, better financial futures.
Investing involves risk including possible loss of principal. There can be no guarantee that the investment objective of any strategy will be fulfilled. Certain retirement strategies run the risk that the principal balance of the portfolio may be depleted prior to a portfolio's target end-date and, therefore, distributions may end earlier than expected. This risk increases if the distribution amount chosen is a significant portion of the starting principal.
Due to the ever changing nature of investments and retirement objectives, it is critical that a retirement investment plan is revisited at least once a year, and more frequently if possible.
This information should not be relied upon by the reader as research or investment advice and is for educational purposes only. This information is not intended to be a forecast of future events, or a guarantee of future results.
Some information contained herein has been provided to SEI by unaffiliated third parties. SEI cannot guarantee the accuracy or completeness of the information and assumes no responsibility or liability for its incompleteness or inaccuracy.
1 "History of PBGC,” https://www.pbgc.gov/about/who-we-are/pg/history-of-pbgc
2 “The History of Retirement Benefits,” https://www.workforce.com/news/the-history-of-retirement-benefits
3 “Provisional Life Expectancy Estimates for January through June, 2020,” https://www.cdc.gov/nchs/data/vsrr/VSRR10-508.pdf. “Life expectancy at birth, total (years) – United States,” https://data.worldbank.org/indicator/SP.DYN.LE00.IN?locations=US
4 “Survey of Consumer Finances, 1989-2019,” U.S. Federal Reserve https://www.federalreserve.gov/econres/scfindex.htm
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