Saturday, December 06, 2014

First Things First

This may be the time of year when thoughts turn to stockings hung by the chimney with care, but it’s also the time of year when parents have to deal with assembling some of the things in those packages. And while Santa may have elves on staff to undertake the construction of a tricycle, dollhouse or Little Tykes airplane seesaw, in our house, that "elf" was named “Dad.”

A painful lesson learned over those years was the importance of following the instructions. No matter how self-evident the process appeared at the outset, or how much I thought I remembered assembling something similar in the not-too-distant past, lurching ahead and tackling things in the order I thought made most sense was inevitably a formula for disaster. And then there was the year some miscreant had apparently “liberated” the assembly instructions from the package. Since it was Christmas Eve by the time I discovered this, all I had to go by was common sense and the picture of the finished product on the package.

Debates about the best way to achieve retirement security often seem to resemble an assembly without a set of directions — frequently without even the benefit of an agreed-upon “picture” of what the finished product is supposed to look like.

A recent hearing held by the Bipartisan Policy Commission focused on three key threats to retirement security: longevity (the risk of outliving your resources), leakage (the distribution of retirement funds prior to retirement) and the costs associated with long-term care (LTC).

Jack VanDerhei, research director for the nonpartisan Employee Benefit Research Institute (EBRI), demonstrated the impact that each of these three events can have on retirement security. With regard to leakage, he explained that more than one in five of the middle 50% who are simulated to run short of money in retirement with leakages present would have sufficient funds if leakages were completely prevented. Unlike many who tout this as a solution, however, he took pains to acknowledge that that assumed no response from participants (such as individuals deciding to contribute less (or not at all) if they knew that they wouldn’t have access to those funds prior to retirement.

Of course, once you have attained retirement, longevity risk — the risk of outliving your resources — becomes a factor. VanDerhei noted that while nearly two-thirds (62%) of the middle 50% are simulated to have sufficient retirement income, those in the longest relative longevity quartile — who would live the longest — only had a 33% chance.

One potential solution —a qualifying longevity annuity contract, or QLAC — didn’t help much. Modeling the impact of a 25% QLAC on retirement readiness, and even among those projected to live longest, VanDerhei found increases in retirement readiness of only 6.6% for early Boomers and 9.6% for Gen-Xers. Overall — that is, with no filter for longevity — this option actually reduced retirement readiness, due to the expense of these arrangements.

As for LTC expenses, while this won’t be an issue for everyone, it can have an enormous impact on the retirement security of those who are affected. VanDerhei explained that only 17% of the middle 50% of those in the top LTC quartile (those most likely to incur those expenses) will have sufficient retirement income.

Ultimately, while each of the three highlighted elements (leakage, longevity and LTC) had an impact on retirement readiness, EBRI’s numbers indicate that a bigger threat is simply not being eligible for a workplace retirement plan. How big a difference? Well, looking at the second and third income quartiles (the “middle 50%”) of Gen-Xers, the probability of not running short of money in retirement soars from 51% to 80% when you compare those with no future years of eligibility in a DC plan to those with 20 or more years.

Put another way, regardless of which solutions are put forth to deal with issues like leakage, longevity and long-term care, they’ll be of little value to those who lack access to a workplace retirement plan.

It’s not just a matter of priority — it’s all about putting the “first thing” first.

- Nevin E. Adams, JD

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