A July 2022 study conducted by the Center for Retirement Research of Boston College concludes that in general, “retirees do not have an accurate understanding of their true retirement risks,” and these retirees often underestimate the importance of setting up resources to provide lifetime income.
The study compared the “objective” risks retirees face, based on hard data, with the “subjective” risks, meaning how retirees themselves perceive their risks. It found “a significant disconnect” between actual and perceived risks.
Five Key Areas of Risk:
1. Longevity Risk: The risk of living longer than expected and exhausting one’s resources.
2. Market Risk: As associated with market volatility affecting retirement investments and also risks in the housing market.
3. Health Risk: Meaning unexpected medical expenses, long-term care needs, and out-of-pocket expenses that can rise quickly with age.
4. Family Risk: This risk includes the effects of divorce, death of a spouse, and adult children becoming dependent on their parents. The study notes these risks could have an effect over a long period of time.
5. Policy Risk: For example, if Social Security’s trust fund reserves get depleted as some projections say, retirees could experience benefit reductions.
How Risks Are Assessed:
This study mainly used data from the Health and Retirement Study (HRS), described as “a biennial longitudinal survey of a representative sample of U.S. households over age 50.” The HRS interviews approximately 20,000 respondents every two years on subjects like health care, housing, assets, pensions, employment, and disability. It is said to be the most comprehensive such survey of older Americans, providing high-quality data. Getting Started: How to Use This Site | Health and Retirement Study (umich.edu)
Objective vs. Subjective Risk Assessment
Looking at the study results, the biggest risk in the objective ranking (based on hard data) is longevity risk, followed by health risk and then market risk. But in the subjective ranking (based on retirees’ perceptions), market risk ranked first, followed by longevity risk and health risk. The study authors say this shows misperceptions by retirees, such as the fact their expectation of market volatility is exaggerated while they underestimate how long they might live and also what their health costs will be in later life.
As one example of this objective vs. subjective disconnect, 65-year-olds were asked to say what they thought was their percentage chance of living to age 80, and this was compared to probabilities given by data-driven empirical life tables. Men thought they had a 58% chance to reach 80; women said they had a 64% chance. But the life tables project men have a 66% chance to reach 80 and women have a 75% chance. In short, retirees are overly pessimistic about their longevity, which can affect how they plan to finance their retirement years. The longevity numbers we typically see are projections based on the current year of a baby born in that year. What is far less emphasized is remaining years of life expected after reaching a certain age. See CDC tables here: 2020 Longevity Table Based on Current Age[BB1]
Similarly, when queried about expectations of future market volatility, retirees’ subjective perceptions predicted much larger volatility than what historic trends and current assessments project. This same sort of objective vs. subjective disconnect occurred in expectation of volatility in home values—that is, retirees overestimate such volatility.
By contrast, older people underestimate what their medical spending is likely to be as they continue to age. What is perhaps particularly surprising, the study showed that retirees do not appreciably adjust their medical spending expectation as they age. They project they will spend roughly the same at age 65 as they will at age 85. For example, the monthly cost of in-home care in 2022 in the Denver area is about $7000. (See Cost of Long Term Care by State | Cost of Care Report | Genworth)
The study authors see three basic implications in the study findings:
- Retirees do not have an accurate understanding of their true retirement risks, especially with regard to longevity and health spending. This highlights the importance of educating the public on the most significant sources of risk.
- Taken together, the longevity and market risks underscore the need for setting up lifetime income, including Social Security plus other lifetime income options (e.g., carefully chosen annuities).
- With the health spending factor, long-term care is also a significant risk faced by retirees, but one they often underestimate. The authors recommend considering better designed public programs and private products to protect retirees with limited financial resources from this potentially catastrophic risk.
The minimum take-away from this study is that retirees, whether designing their financial plans on their own or working with advisors, need to take great care that they are basing their plans on objective data and not relying on subjective perceptions and assumptions that could leave them inadequately prepared for living out their retirement years in the way they hope to.