Review Cause

By Nevin Adams, EBRI

AdamsWhen I was still a child, my parents owned a 1958 VW Beetle. I was pretty young, so I don’t remember much about that car, other than the color, and what struck me, even as a child, as the “odd” reversal of the trunk and engine. One thing I do remember is that it didn’t have a gas gauge. Instead, there was a reserve tank switch, and when the engine started sputtering, you opened the valve, and got enough “extra” gas to get to a gas station.

The trick was that you had to remember to leave that reserve open when you filled up―if you didn’t, well then, you had no reserve. As you might expect, the reason I remember that relatively obscure feature to this day is a trip that was “interrupted” when my family discovered the hard way that my father had forgotten to reset the reserve switch.

Retirement planning typically focuses on looking to ensure that your post-retirement income sources are adequate to replicate some percentage of your preretirement income level. Underlying that approach is the assumption that individuals incur roughly the same kinds of expenses in retirement, although the amount, and proportionate share, of those expenses can certainly shift, particularly in areas such as health care. Indeed, while EBRI’s Retirement Security Projection Model®  (RSPM) and Retirement Readiness Rating have long incorporated the uninsured costs of post-retirement health care and long-term care, a few other  retirement projection models only recently acknowledge post-retirement health care costs as a discrete retirement savings need.

As a recent EBRI Notes article[1] explains, individuals should be concerned about saving for health insurance premiums and out-of-pocket expenses in retirement for a number of reasons. Medicare generally covers only about 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 12 percent.[2] The percentage of private-sector establishments offering retiree health benefits has been falling, and where benefits are offered, they are becoming less generous, even in the public sector.

While EBRI’s analysis indicates that savings targets for post-retirement health expenses (other than nursing home and home health care costs) declined between 6 percent and 11 percent between 2012 and 2013 for a person or couple age 65, there are a wide variety of possible outcomes, depending not only on the age at which an individual retires, but also the length of life after retirement, the availability and source of health insurance coverage after retirement to supplement Medicare, their health status and out-of-pocket expenses, the rate at which health care costs increase, the impact of interest rates and other rates of return on investments, as well as possible changes in public policy―not to mention the targeted probability of success of those targets.

Remember that while it is possible to come up with a single number that individuals can use to set retirement savings goals, a single number based on averages will be wrong for the vast majority of the population.

But, as with that old VW Beetle, those who set savings targets that fail to set aside any reserve for the eventuality might well wind up short of their destination.

Notes


[1] The EBRI Notes article, “Amount of Savings Needed for Health Expenses for People Eligible for Medicare: More Rare Good News” is online here.

[2] Note that many individuals will need more than the amounts cited in this report because this particular analysis does not factor in the savings needed to cover long-term care expenses, nor does it take into account the fact that many individuals retire prior to becoming eligible for Medicare. However, some workers will need to save less than what is reported if they choose to work during retirement, thereby postponing enrollment in Medicare Parts B and D if they receive health benefits as active workers.

“After” Images

By Nevin Adams, EBRI

Adams

Adams

“Replacement rates”—roughly defined as the percentage of one’s pre-retirement income available in retirement—arguably constitute a poor proxy for retirement readiness.

Embracing that calculation as a retirement readiness measure requires accepting any number of imbedded assumptions, not infrequently that individuals will spend less in retirement. While there is certainly a likelihood that less may be spent on such things as taxes, housing, and various work-related expenses (including saving for retirement), there are also the often-overlooked costs of post-retirement medical expenses and long-term care that are not part of the pre-retirement balance sheet.

That said, replacement rates are relatively easy to understand and communicate, and, as a result, they are widely used by financial planners to facilitate the retirement planning process. They are also frequently employed by policy makers as a gauge in assessing the efficacy of various components of the retirement system in terms of providing income in retirement that is, at some level, comparable to that available to individuals prior to retirement.

A recent EBRI analysis looked at a different type of measure, one focused on the years prior to the traditional retirement age of 65, specifically a post-65 to pre-65 income ratio. The analysis was intended to provide a perspective on household income five and 10 years prior to age 65 compared with that of household income five and 10 years after age 65, specifically for households that didn’t change marital status during those periods. Note that in some households at least one member continues to work after age 65 (part-time in many cases) and may not fully retire until sometime after the traditional retirement age of 65.

Based on that pre- and post-65 income comparison, the EBRI analysis finds that those in the bottom half of income distribution did not experience any drop in income after they reached 65, although the sources of income shifted, with drops in labor income offset by increases in pension/annuity income and Social Security.

That was not, however, the case for those in the top-income quartile, who experienced a drop in income as they crossed 65, with their post-65 income levels only about 60 percent of that in the pre-65 periods.

This is not to suggest that the lower-income households were “well-off” after age 65. Changes in marital status, not considered in this particular analysis, particularly in the years leading up to (and following) retirement age, can have a dramatic impact on household income.

The current analysis does, however, show that Social Security’s progressivity is serving to maintain a level of parity for lower-income households with household income levels in the decade before reaching age 65, and in some cases to improve upon that result—and it helps underline the significance of the program in providing a secure retirement income foundation.

The EBRI report, published in the September EBRI Notes, “How Does Household Income Change in the Ten Years Around Age 65?” is available online here.

Balancing “Acts”

By Nevin Adams, EBRI

Adams

Adams

Last week we looked at how the trends in employment-based retirement plans and employment-based health plans seem to be heading in opposite directions: fewer choices for workers to make in the former, more in the latter (see Consumer “Driven,” online here.  Recent EBRI research suggests a potential divergence in other areas as well.

According to the EBRI/MGA Consumer Engagement in Health Care Survey, 26–40 percent of respondents reported some type of access-to-health-care issue for either themselves or family members last year. “Access” in this case refers not to availability, per se, but is broadly defined as not filling prescriptions due to cost, skipping doses to make medication last longer, or delaying or avoiding getting health care due to cost.

Not surprisingly, access is more of a problem among those with lower incomes, who appear to be forgoing spending on health care. In fact, regardless of health plan type, individuals in households with less than $50,000 in annual income were more likely than those in households with $50,000 or more in annual income to report access issues. In sum, a number of individuals, notably lower-income workers, were restricting their spending on healthcare.¹

Another recent EBRI analysis  found that lower-income workers were withdrawing money from their individual retirement accounts in much greater numbers, earlier, and at much larger percentages, than other workers. In fact, the report noted that nearly half (48 percent) of the bottom-income quartile of those between the ages of 61 and 70 had made such an IRA withdrawal, and that their average annual percentage of account balance withdrawn (17.4 percent) was higher than the rest of the income distribution. In sum, a number of individuals, again, notably lower-income workers, were withdrawing more from their retirement savings accounts than those in higher income groups.

One of the great hopes behind a growing emphasis on consumer-directed health plans is that individuals would make different, perhaps more efficient decisions about their health care. Of course, one of the looming concerns is that individuals would make ill-informed decisions influenced by short-term personal economic (rather than health) factors. Similarly, there have been concerns expressed that, left to their own devices, individuals will withdraw too much money too soon from their retirement accounts—that their decisions too will be motivated by short-term needs, rather than by a full appreciation for the longer-term consequences of those actions.

As previous EBRI research has documented, the availability of health insurance may not only affect retirement decisions, but the costs of health care and long-term care can have a very real impact on retirement income adequacy.² The trends highlighted in the EBRI analyses suggest that some—notably lower-income individuals—could be spending less on healthcare than they might, and perhaps drawing more from their retirement accounts than they should.

What’s not yet clear—and what future research may shed light on—is whether these actions are borne of necessity, are simply random and potentially ill-considered, or are the result of conscious (and perhaps conscientious) choice.

Notes

¹ Some additional evidence of the trend was highlighted by EBRI research recently published in Health Affairs, specifically that consumer-directed health plans (CDHPs) were shown to reduce the long-term use of outpatient physician visits and prescription drugs. Link is online here.

² See Views on Health Coverage and Retirement: Findings from the 2012 Health Confidence Survey, and ‘Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News.” 

See also “Lessons From the Evolution of 401(k) Retirement Plans for Increased Consumerism in Health Care: An Application of Behavioral Research,” online here.

Predict-Able

By Nevin Adams, EBRI

Retirement planning is a complex and highly individualized process, but many people find it easier to start by focusing on a single, specific target number.

For those interested in a single number for health care expenses in retirement, a recent EBRI report provides that.  Among other things, the report noted that a 65-year-old man would need $70,000 in savings and a woman would need $93,000 in 2012 if each had a goal of having a 50 percent chance of having enough money saved to cover their projected health care expenses in retirement.  A 65-year-old couple, both with median drug expenses, would need $163,000 in 2012 to have a 50 percent chance of having enough money to cover health care expenses.1

Determining how much money is needed to cover health care expenses in retirement is complicated.  It depends on retirement age, the length of life after retirement, the availability and source of health insurance coverage after retirement to supplement Medicare, the rate at which health care costs increase, interest rates, market returns, and health status, among other things.  That said, it is possible to project health care expenses with some accuracy, and EBRI’s recent analysis uses a Monte Carlo simulation model to estimate the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses in retirement.

However, those recent “single number” projections specifically excluded the financial impact of long-term care.

EBRI has long acknowledged the critical impact that health care expenses can have on retirement finances, and considering that EBRI has long incorporated both the costs of health care and long-term care in its Retirement Savings Projection Model® (RSPM), one might well wonder why this particular report specifically excluded those long-term care projections.

For all the complexity in those calculations, the reality is that everyone won’t have to deal with the expenses associated with long-term care.  For those who will, the impact on retirement finances could be significant, even catastrophic.2  That’s why EBRI has modeled their impact in the RSPM since 2003.

As noted above, for those interested in a single number, the recent EBRI report provides that, along with variations that permit one to take into account different likelihoods of success and gender/marital combinations.  We are able to do that because we treat longevity risk and investment risk stochastically,3 and the fact that those expenses (and the costs of insurance) are, at least relatively, predictable.

But while it is possible to come up with a single number that individuals can use to start setting retirement-savings goals, it is important to bear in mind that a single number based on averages will be wrong for the vast majority of the population—and that those who rely exclusively on that single number run the risk of running short.

Notes

1 Unlike reports produced by a number of organizations, the EBRI report also provided estimates for those interested in a better-than-50-percent chance of success.  See ”Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News,” online here.

2 The EBRI Notes article above illustrates the difference: If you ignore the impact of nursing home and home health care expenses, more than 90 percent of single male Gen Xers were projected to have no financial shortfall in retirement—but when that impact was included, just 68 percent of that group was projected to have no financial shortfall in retirement.  The error of ignoring nursing home and home health care costs is even more profound if one focuses on the percentage of individuals with shortfalls in excess of $100,000. 

3 For an expanded description of the difference stochastic modeling can make, see “Single Best Answer.”

See also:  “Employment-Based Retiree Health Benefits: Trends in Access and Coverage, 1997-2010”, and “Effects of Nursing Home Stays on Household Portfolios.”

“Grayed” Expectations?

By Nevin Adams, EBRI

Even the best retirement planning requires a fair number of assumptions: the age at which you hope to retire, for one thing; the amount of income that living in retirement will require; the length of time over which your retirement will last; the rate of return on your savings prior to, and following, retirement; the sources of retirement income that will be available to you, and in what amount(s).

Consider that in the 2012 Retirement Confidence Survey while worker confidence in having enough money to pay basic expenses in retirement wasn’t exactly high (only 26 percent were very confident), workers were noticeably less likely to feel very confident about their ability to pay for medical expenses after retirement (13 percent) and even less likely to feel very confident about paying for post-retirement long-term care expenses (9 percent) — levels that have remained statistically unchanged since 2010.

Indeed, the lack of employment-based retiree health insurance may result in unanticipated expenses in retirement. In the 2011 RCS, one-third of workers reported that they expected to receive this type of insurance from an employer (36 percent), though only 27 percent of retirees in that survey actually received it.

Earlier research found little impact of reductions in coverage on retirees, but the report notes that that may be because initial changes employers made to retiree health benefits affected future retirees, rather than those retired at the point of change.  A recent EBRI Issue Brief highlights that, over time, more and more retirees have “aged into” those program changes, resulting in the greater impact found in more recent studies.  The report also notes that most employers that continue to offer retiree health benefits have made changes in the benefit package they offer, changes that impact both the cost and availability of the benefit, including raising premiums that retirees are required to pay, eliminating employer subsidies, tightening eligibility, limiting or reducing benefits, or some combination of these.

However, as that Issue Brief also notes, very few private-sector employers currently offer retiree health benefits, and the number offering them has been declining, even in the public sector:  Between 1997 and 2010, the percentage of non-working retirees over age 65 with retiree health benefits fell from 20 percent to 16 percent.  Still, expectations seem to outpace reality; in 2010, 32 percent of workers expected retiree health benefits, while only 25 percent of early retirees and 16 percent of Medicare-eligible retirees actually had them.

Circumstances change, expectations matter, and retirement planning that relies on flawed or outdated expectations can, unfortunately, leave us short of where we need to be.

Notes

See Employment-Based Retiree Health Benefits: Trends in Access and Coverage, 1997‒2010

Rely-Able?

By Nevin Adams, EBRI

Adams

Last week the Center for Retirement Research at Boston College provided an update on its National Retirement Risk Index (NRRI).¹ The impetus for the update was the triennial release of the Federal Reserve’s Survey of Consumer Finance (SCF), published in June, reflecting information as of December 2010.

Now, many things have changed since 2007, and in the most recent iteration of the NRRI, the authors note five main changes: the replacement of households from the 2007 SCF with those from the 2010 SCF; the incorporation of 2010 data to predict financial and housing wealth at age 65; a change in the age groups (because a significant number of Baby Boomers have retired, according to the report authors); the impact of lower interest rates on the amounts provided by annuities; and changes in the Home Equity Conversion Mortgage (HECM) rules that lowered the percentage of house value that borrowers could receive in the form of a reverse mortgage at any given interest rate.

And, when all those changes are taken into account, the CRR analysis concludes that, as of December 2010, anyway, the percentage of households (albeit those from a partially different cohort) at risk of being unable to maintain their pre-retirement standard of living in retirement increased by 9 percentage points² between 2007 and 2010 (from 44 percent at risk to 53 percent).

When the baseline for your analysis is updated only every three years, it’s certainly challenging to provide a current assessment of retirement readiness. In previous posts, we’ve covered the limitations of relying solely on the SCF data³and, to some extent, the apparent shortcomings of the NRRI (see “’Last’ Chances”), and retirement projection models, generally (see “’Generation’ Gaps”).

On the other hand, the impact of the decline in housing prices and the stock market were modeled by EBRI in February 2011 (see “A Post-Crisis Assessment of Retirement Income Adequacy for Baby Boomers and Gen Xers”), while the impact of the rising age for full Social Security benefits has been incorporated in EBRI’s Retirement Savings Projection Model (RSPM) since 2003. Moreover, EBRI has also included the potential impact of reverse mortgages in our model for nearly a decade now.

Meanwhile, as a recent EBRI report noted (see “Is Working to Age 70 Really the Answer for Retirement Income Adequacy?”), the NRRI not only assumes that everyone annuitizes at retirement, and continues to ignore the impact of long-term care and nursing home costs (or assumes that they are insured against by everyone), but it also seems to rely on an outdated perspective of 401(k)-plan designs and savings trends, essentially ignoring the impact of automatic enrollment, auto-escalation of contributions, and the diversification impact of qualified default investment alternatives.

It’s one thing to draw conclusions based on an extrapolation of information that, while dated, may be the most reliable available. It’s another altogether to rely on that result in one’s retirement planning, or the formulation of policies designed to facilitate good planning.

Notes

¹ The report, “The National Retirement Risk Index: An Update” is available online here.

² The report notes that, between 2007 and 2010, the NRRI jumped by 9 percentage points due to: the bursting of the housing bubble (4.5 percentage points); falling interest rates (2.2 percentage points); the ongoing rise in Social Security’s Full Retirement Age (1.6 percentage points); and continued low stock prices (0.8 percentage points).

³ As valuable as the SCF information is, it’s important to remember that it contains self-reported information from approximately 6,500 households in 2010, which is to say the results are what individuals told the surveying organizations on a range of household finance issues (typically over a 90-minute interviewing period); of those households, only about 2,100 had defined contribution (401(k)-type) retirement accounts. Also, the SCF does not necessarily include the same households from one survey period to the next. See “Facts and ‘Figures.’”

A Moving Target

By Nevin Adams, EBRI

Adams

Trying to figure out how much money an individual or couple needs to live on in retirement is, to put it mildly, a complicated business. Among other factors, it depends on the age at which he or she retires, where they live, and how they live. It can be affected by marital status, their health, and the markets, both before and after retirement.

And, as a recent EBRI Notes article (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”)  explains, it can also be affected by the availability and source of health insurance coverage after retirement to supplement Medicare, and the rate at which health care costs increase.

Additionally, public policy that changes any of the above factors will also affect spending on health care in retirement. Consequently, trying to hit that target can feel like aiming at a bulls-eye that is not only moving, but moving fast, and zig-zagging away from the bouncing, moving vehicle in which you find yourself.

We’re often asked to come up with a single number that individuals can use to set their retirement savings goals—and while it’s certainly possible to do so (and others have), what’s often glossed over is that while that approach appears to offer clarity, a single number based on averages will be wrong for the vast majority of the population.¹ Moreover, frequently overlooked in the generalizations about retirement spending levels is the very real (and potentially huge) financial impact of post-retirement health care expenses.

Individuals will be responsible for saving for health insurance premiums and out-of-pocket expenses in retirement for a number of reasons. Medicare generally covers only about 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 13 percent. The percentage of employers offering retiree health benefits has been falling, even in the public sector, and even when offered, those benefits are becoming less generous and more expensive to the retiree.

Using a simulation model, we recently estimated the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses (excluding long-term care) in retirement. The EBRI article presents estimates for people who supplement Medicare with a combination of individual health insurance through Plan F Medigap coverage and Medicare Part D for outpatient-prescription-drug coverage. For each source of supplemental coverage, the model simulates 100,000 observations to allow for the uncertainty related to individual mortality and rates of return on assets in retirement, and computes the present value of the savings needed to cover health insurance premiums and out-of-pocket expenses in retirement at age 65. From those observations, the analysis determined asset targets for having adequate savings to cover retiree health costs 50 percent, 75 percent, and 90 percent of the time, both for individuals,² and for a stylized couple, both of whom are assumed to retire simultaneously at age 65.³

Of course, some will need more money than the amounts cited in the report, which did not factor in the savings needed to cover long-term care expenses, nor the reality that many individuals retire prior to becoming eligible for Medicare. Some will need to save less than projected if they choose to work during retirement.

Still, as hard as it can be to hit a moving target, it’s even harder to hit a target you can’t see.

Notes

¹ For more on the shortcomings of this approach, see “Single Best Answer.”

² Separate estimates are presented for men, women, and married couples. Because women have longer life expectancies than men, women will generally have larger expenses than men to cover health insurance premiums and health care expenses in retirement, regardless of the savings target.

³ Our analysis found a 1–2 percent reduction in needed savings among individuals with median drug use and 4-5 percent reductions in needed savings among individuals at the 90th percentile in drug use since EBRI’s 2011 analysis (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”).

Some Rare Good News: Retiree Health Savings Needs Slip

Projections for how much elderly Americans need to save for out-of-pocket health care in retirement have edged lower, due to a provision the federal health reform law that will cover more of their prescription drug costs, according to a new report by EBRI.

The Patient Protection and Affordable Care Act (PPACA) reduces cost sharing in the Medicare Part D “donut hole” to 25 percent by 2020. This year-to-year reduction in coinsurance will continue to reduce savings needed for health care expenses in retirement, all else equal, for individuals with the highest prescription drug use, EBRI reports.

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) added outpatient prescription drugs (Part D) as an optional benefit. When the program was originally enacted, it included a controversial feature: a coverage gap, more commonly known as the “donut hole.” PPACA included provisions to reduce (but not eliminate) this coverage gap.

Medicare generally covers only about 60 percent of the cost of health care services (not including long-term care) for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 13 percent (see figure, below).

The EBRI analysis finds 1–2 percent reductions in needed savings among individuals with median (mid-point, half above and half below) drug use and 4–5 percent reductions in needed savings among individuals at the 90th percentile in drug use since its last analysis in 2011.

The full report, “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News,” is published in the October EBRI Notes, online at www.ebri.org

The press release is online here.

Workers Aging Into Retiree Health Changes

A growing number of workers are realizing they will not get retiree health care from their employer after they stop working, according to a new report by EBRI.

While earlier research found little impact from reductions in coverage on current retirees, EBRI finds that initial changes employers made to retiree health benefits affected future retirees as opposed to then-current retirees. Over time, more and more retirees have “aged into” those program changes, resulting in the greater impact found in more recent studies.

Paul Fronstin, head of health benefits research at EBRI, and co-author of the report, noted that for many years, despite the downward trend in retiree health coverage, many workers still thought they would receive the benefit.

“The data show that workers are still more likely to expect retiree health benefits than retirees are actually likely to have those benefits, but the expectations gap is closing,” Fronstin said. “By 2010, 32 percent of workers expected retiree health benefits, while only 25 percent of early retirees and 16 percent of Medicare-eligible retirees had them.”

The EBRI report, providing current data on trends in retiree health coverage, finds that while many employers no longer offer retiree health benefits, most that have continued to do so have made changes in the benefit package they offer: raising premiums that retirees are required to pay, tightening eligibility, limiting or reducing benefits, or some combination of these.

The full report, “Employment-Based Retiree Health Benefits: Trends in Access and Coverage, 1997‒2010,” is published in the October EBRI Issue Brief, online at www.ebri.org   The press release is online here. The full report is online here.

The Impact on the Uninsured of the Baby Boom Generation Reaching Age 65

By Paul Fronstin, EBRI

This week the Census Bureau released its annual report on income, poverty and the uninsured. The number of uninsured increases naturally because of population growth even when the percentage declines, but in 2011 both the percentage of the population and the number uninsured declined: Between 2010 and 2011, the percentage uninsured fell from 16.3 percent to 15.7 percent and the number fell from 50 million to 48.6 million. In fact, 2011 was only one of four years since 1994 that saw a decline in the percentage uninsured.

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Why did both those measures fall in 2011?

Some segments of the population did see an increase in employment-based coverage, notably young adults taking advantage of the adult dependent mandate in the Affordable Care Act (ACA), but these gains were offset by other loses (such as the decline in coverage from one’s own job for workers of all ages), negating any impact on the aggregate decline in the uninsured. The percentage of the population with employment-based health benefits stood at 55.1 percent in 2011, compared with 55.3 percent the previous year, so it would not account for the decline in the uninsured.

There was growth in the number of people covered by Medicaid and SCHIP (the State Children’s Health Insurance Program). In 2011, 16.5 percent of the population had Medicaid or SCHIP, up from 15.8 percent in 2010. So this increase accounted for some of the decline in the uninsured.

Overall, the decline in uninsured was largely associated with a rise in the share of people covered by government-sponsored health plans, increasing to 32.2 percent in 2011 from 31.2 percent in 2010.

Coincident with this trend, it’s worth noting that the leading edge of the Baby Boom generation (the cohort of individuals born between 1946‒1964) turned 65 in 2011, meaning that this generation is finally reaching Medicare eligibility.

Statistically, 65-year-olds have now reached 1 percent of the total U.S. population. While not yet a large number, it is the largest in recent history, driving up Medicare enrollments, and perhaps marking the cusp of a significant demographic shift in insurance trends.

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