A new analysis released by the Employee Benefit Research Institute (EBRI), “What Causes EBRI Retirement Readiness Ratings to Vary: Results from the 2014 Retirement Security Projection Model,” reveals that overall retirement income adequacy has improved in recent years and fewer households are likely to run short of money during retirement. However, factors such as age, income and access to an employer-sponsored 401(k)-type retirement plan can still produce substantial individual differences in readiness.
Findings from the report show that eligibility for participation in an employer-sponsored 401(k)-type plan remains one of the most important factors for achieving retirement income adequacy. Gen Xers in the lowest-income quartile with 20 or more years of future eligibility in a defined contribution plan are half as likely to run short of money as those with no years of future eligibility, the report shows. The impact of access to a 401(k)-type plan is also positive, but less pronounced, for those in the middle-income quartiles. EBRI’s research shows investors in the middle income range experience increases in retirement readiness ratings (a proprietary readiness measure from EBRI) of about 3% when given similar access to a defined contribution plan, increasing from 27.1% to 30.3%.
With regard to longevity and the high cost of health care, the report shows these two factors in particular can drive huge variations in retirement income adequacy. For both of these factors, a comparison between the most risky quartile—i.e. those most likely to experience high health care costs—with the least risky quartile shows a spread of approximately 30 percentage points in readiness for the lowest income range, approximately 25 to 40 percentage points for the highest income range, and even larger spreads for those in the middle income ranges.
The report also finds that annuities and long-term care insurance could mitigate much of the variability in retirement income adequacy experienced at or near retirement age. For example, the annuitization of a portion of a worker’s defined contribution and individual retirement account (IRA) balances may substantially increase the probability of not running short of money in retirement. In addition, the report notes that a well-functioning market in long-term care insurance could provide an extremely useful way to help control the volatility from the stochastic, long-term care risk, especially for those in the middle-income quartiles.
Future Social Security benefits make a huge difference for the retirement income adequacy of some households, notes the report, especially Gen Xers in the lowest-income quartile. If Social Security benefits are subject to proportionate decreases beginning in 2033 (when the Social Security Trust Fund is projected to run short of money), the retirement readiness values for those households are projected by EBRI to decreases from 20.9% to 10.3%.
“It would appear that while retirement income adequacy depends to a large degree on the household’s relative wage level and future years of eligibility in a defined contribution plan, a great deal of the variability in these values could be mitigated by appropriate risk-management techniques at or near retirement age,” concludes Jack VanDerhei, EBRI research director and author of the report.
The full report is published in the February EBRI Issue Brief at www.ebri.org.