New Factors That Can Impact Retirement Readiness

Market performance is not the only indicator of retirement readiness, according to researchers at the University of Connecticut.

Four non-economic factors—measuring the individual’s health status at retirement, the level of job satisfaction, amount of financial planning, and level of adaptability—are used in a new retirement index to assess financial readiness that fundamentally differs from traditional predictors.

“National Risk Sustainability Index (NRSI): A Paradigm Change to Measuring Retirement Preparedness” details the tool, which was developed at the Goldenson Center for Actuarial Research at the University of Connecticut.

“This is a paradigm shift in how people are viewing retirement,” says Jay Vadiveloo, professor of mathematics and director of the Goldenson Center, who set out to measure several other factors that affect one’s preparedness for retirement, in an attempt to provide “a more holistic measure.”

The standard way of measuring an individual’s ability to retire compares their current net assets with the projected value of those assets at some point in the future. The problem, according to Vadiveloo, is that those projections are hugely dependent on the performance of financial markets.

Vadiveloo has several criticisms of the more usual retirement readiness yardsticks. They don’t use national U.S. data, and they are updated infrequently. But it is the inclusion of solely economic data that is his biggest complaint. “These retirement indices are directly correlated with the current state of the economy and tend to portray a negative image of retirement readiness during adverse economic times, which could be misleading,” he says.

The index attempts to overcome these limitations by capturing both economic and non-economic drivers of retirement preparedness into a single measure, which ranges from 0 to 100. The higher the measure, the greater the sustainability at retirement. The index, based on publicly available U.S. Census data and other nationally recognized data sources, will be updated annually. Its values are logical, consistent and academically rigorous, the paper contends, as well as simple to describe and interpret. It can also compare retirement sustainability for different segments of the population.

The new measure, which he calls the National Retirement Sustainability Index, adds four factors to the basic model of readiness. Health at retirement, job satisfaction, level of financial planning and of adaptability give a more complete picture of what a person’s retirement is apt to look like, Vadiveloo says in his report, and can broaden the list of options people can use to improve their retirement outlook, even during an economic downturn.

The paper outlines the methodology of the index: The baseline index is similar to the more traditional indices, and is based on economic assets available at retirement and compared to future obligations or liabilities that need to be met throughout an individual’s retirement. Assets and liabilities are accumulated and discounted, using typical interest rate assumptions and actuarial survival rates.

The net equity (assets less liabilities) is then normalized to range from 0 to 100 by comparing the net equity to a benchmark equity, which reflects the standard of living enjoyed just before retirement. For example, an NRSI of 50% means that to achieve retirement sustainability or readiness, one’s standard of living at retirement should be reduced to half of what it used to be just prior to retirement.

The higher the NRSI, the closer retirement living standards are relative to living standards prior to retirement. The NRSI value is best understood by comparing the NRSI between groups at a given time period or for the same group across time. For example, an increase in the NRSI between two successive time periods from 50 to 55 should be interpreted as a 10% improvement in the level of retirement living standards over the two time periods.

The baseline NRSI is then adjusted to include the four non-economic drivers of retirement sustainability (health, job satisfaction, amount of financial planning, and level of adaptability).

Adaptability, the non-economic driver with the greatest impact on the NRSI for both the working and retiree population, is a reflection of the individual’s ability to generate additional or part-time income while retired. This factor captures a retiree’s potential and is not a measure of the actual part-time income earned by retirees.

A retired professor in good health, for example, has the potential to pick up some part-time teaching duties to supplement her retirement assets, and the adaptability measure attempts to estimate this potential income and its impact on retirement sustainability.

In order to model this potential part-time income at retirement, the index used the Health and Retirement Study (HRS) database to model retirees who indicated earning part-time income. The study contends that the potential to earn additional income during retirement is positively correlated with the level of education and negatively correlated with increasing age.

According to Vadiveloo, the index demonstrates that people should view retirement readiness as a state of affairs they can personally manage and control, and not as a manifest destiny driven by economic conditions.

“Perhaps the easiest example is health,” Vadiveloo says. “The healthier you are at retirement, the lower your health care costs are going to be.” An individual who invests in his own health through diet and exercise, for example, will likely see the value of the index increase. Similarly, individuals who have more “adaptability”— the ability and willingness to try different types of work—are likelier to earn supplementary income after retirement, which also increases the value of the index.

Although the index cannot project happiness or satisfaction at retirement, it is using those non-economic inputs to construct a more complete picture of financial readiness at retirement.

“We have taken these seemingly subjective measures and quantified them in a rigorous way,” he says. Vadiveloo is hopeful that the NRSI will be used by professionals in financial services to help people plan for retirement.

Development of the index was supported by the Janet & Mark L. Goldenson Center for Actuarial Research at the University of Connecticut, a research group for applied actuarial research that is dedicated to helping academia and industry work collaboratively to solve problems in the field. A full version of the report describing the index can be found here.