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6. Retirement Choices

In addition to the three traditional sources of retirement income — Social Security, Employment-Based Plans, and Personal Savings — there is an emerging Fourth Pillar of retirement in America today: Retirement Choices. This Pillar is becoming increasingly relevant given the convergence of a few key trends:
• Longer retirements:
- while lifespans are increasing, the average retirement age is decreasing. In the 1950s, workers retired at about age 68; by the late 1990s, the average retirement age was between 62 and 63¹⁹. The result is a longer retirement for many Americans.
• Rising healthcare costs and declining healthcare coverage:
- healthcare spending is rising at about four times the rate of inflation²⁰, dramatically impacting the amount that older Americans are projected to have to spend on healthcare.
- By 2030, health spending is expected to represent about one-third of the after-tax household income of older Americans²¹.
These trends, coupled with the decreasing availability of DB plans and the general insufficiency of Americans’ DC plan accumulations and personal savings, give rise to some considerations that are different for today’s retirees than they were for their parents.
The ‘Retirement Choices’ Pillar is intended to capture:
• Non-traditional sources of retirement income:
- Working to supplement retirement income or for personal enjoyment.
- Tapping into home equity to fund retirement living.
• Income protection:
- Providing a more secure retirement for a surviving spouse as well as providing for future generations.
- Protecting retirement income from the rising costs of healthcare or long-term care.

6.1 Retirement Choices: Non-Traditional Sources of Retirement Income Working in Retirement

Some retirees wish to work during their retirement years for personal fulfillment. Many others do so out of economic need, given the trends in pension and healthcare coverage. A recent Prudential Financial survey indicates that most pre-retirees intend to work, at least part-time, in retirement.

Figure 8: Intention of working in retirement

Source: Prudential Financial (2005), Roadblocks to Retirement.

Despite the desire and/or need to work in retirement, retirees often face impediments in trying to do so:
• Often, phased retirees (workers who ‘phase’ into retirement by voluntarily reducing hours worked) cannot draw a pension and a salary from the same employer²².
• Almost one-third of employers do not offer health benefits for phased retirees²³.
• Individuals who are receiving Social Security benefits but who have not reached full retirement age lose one dollar in benefits for every two dollars earned over $12,480. In the year they reach full retirement age, they lose one dollar in benefits for every three dollars earned over $33,240 ($2,767 per month)²⁴.
• Social Security retirement benefits become subject to income taxes if earnings exceed a threshold figure, currently $25,000 for individuals or $32,000 for couples filing taxes jointly²⁵.

6.2 Tapping into Home Equity

For many seniors, their homes represent the great majority of their wealth. Seventy-eight percent of households with at least one member aged 65 or older own their own homes; for these households, home equity values average nearly 80% of net worth²⁶.
According to a recent survey conducted by Prudential, Americans believe that real estate values — more than any other factor reviewed — had helped their retirement prospects over the past five years. Additionally, almost half of respondents indicated that, within ten years after retirement, they anticipated moving to a smaller house or an area with a lower cost of living, which implies unlocking some equity in the home.
For retirees who need funds but who wish to remain in their current homes, options may include reverse mortgages. With a reverse mortgage, the homeowner borrows against the value of the home. No payments are made on the loan, but interest accrues on the loan balance, which must be paid when the last owner of the property vacates, either upon death or by selling the home²⁷.

Figure 9: Expectation of relocation in retirement

Source: Prudential Financial (2005), Roadblocks to Retirement.

6.3 Retirement Choices: Protecting Retirement Income Providing for Family

Just as active workers use life insurance to provide financial protection for their families against the loss of an income earner, retirees can utilize life insurance in the same way. A life insurance death benefit can serve as supplemental retirement income to a surviving spouse or dependent, who may have inadequate retirement income of his or her own and, in the case of women, have a longer life expectancy.
Additionally, while the primary purpose of life insurance is to provide a death benefit, life insurance cash values may serve as a buffer to help meet retirement income needs — through loan provisions, conversion to annuity, or cash surrender. Of course, accessing cash values will reduce policy values and death benefits, and may have tax consequences. Life insurance also plays a key role in estate planning. The death benefit can guarantee that something will be passed on to a retiree’s heirs — generally income tax free [IRC 101 (a)] — regardless of the extent to which othe assets were used to fund retirement living. This benefit might even serve as recompense to family members who provided for the retiree during his or her lifetime.
Whether viewed as a supplemental source for retirement income, a way to provide for surviving family members and loved ones, or a way to pass something on to future generations, life insurance can help address many retirement protection needs.

6.4 Providing for Long-term Care

Long-term care insurance has become an important consideration in protecting retirement savings as well as the income generated by those savings. According to 2006 Prudential research, nursing home costs can reach $165,000 to $185,000 for the average two- to three-year stay, more than the net worth of most elderly Americans28.
In a recent Prudential survey, over 40% of respondents indicated that they believe they will need nursing home care in the latter part of their retirement.

Figure 10: Likely to require nursing home care among americans 30-69 years of age

Source: Prudential Financial (2005), Roadblocks to Retirement.

Significant percentages of near-retirees expressed concerns about running out of money in retirement, becoming a financial burden to their families, or having money for health care.

Figure 11: Financial goals considered “very important” among near-retirees 55-64 years of age

Source: Prudential Financial company research, 2004.

6.5 Protecting Against Outliving Assets

One form of providing for late-in-life income needs is a deferred annuity which is payable at an advanced age (e.g., 85)—sometimes referred to as ‘longevity insurance’. It is designed to protect retirees from outliving their retirement income.

19 Gendell, M. (2001): “Retirement Age Declines Again in the 1990s”, Monthly Labor Review, October, p. 14, table 1.
20 National Coalition on Health Care: “Facts on Health Insurance Costs”, Press Release.
21 Johnson, R.W. (2004): Will Health Care Costs Erode Retirement Security?, Center for Retirement Research at Boston College, October, p. 4.
22 AARP (2004): Best Practices, Phased Retirement Programs, July 23.
23 WatsonWyatt Worldwide (1999): Executive Summary, “Phased Retirement — Reshaping the End of Work”, p. 3.
24 Social Security Administration, Answers to Your Questions.
25 Social Security Administration, Answers to Your Questions.
26 U.S. Dept. of Health & Human Services Administration on Aging (2003): “Statistics: A Profile of Older Americans” (updated 9/9/04).
27 American Association of Retired Persons: A Fact Sheet on Reverse Mortgages, p. 1.
28  Prudential Financial research on long-Term care, April 2006.

References

Adams, N. (2005): “2005 Defined Contribution Survey”, PlanSponsor Magazine, November.

AARP: A Fact Sheet on Reverse Mortgages.

AARP (2004): Best Practices, Phased Retirement Programs, July 23.

Beatrice, D. (2005): “The 2004 Individual Annuity Market, Sales and Assets”, LIMRA.

Buesing, M. and Soto, M. (2006): “The State of Private Pensions: Current 5500 Data”, The Center for Retirement Research at Boston College, February

Cerulli Associates (2005): Cerulli Quantitative Update, Retirement Markets 2005.

Cerulli Associates (2005): Cerulli Quantitative Update, Retirement Markets 2005.

Gendell, M. (2001): “Retirement Age Declines Again in the 1990s”, Monthly Labor Review, October.

Holden, S. and VanDerhei, J. (2005): 401(k) Asset Allocation, Account Balances, and Loan Activity in 2004, Investment Company Institute, September.

Johnson, R.W. (2004): Will Health Care Costs Erode Retirement Security?, Center for Retirement Research at Boston College, October.

Mandel, M. (2005): “Our Hidden Savings”, Business Week, January 17.

National Coalition on Health Care: “Facts on Health Insurance Costs”, Press Release.

Pasha, S.: More Health Savings Accounts Offered.

Profit Sharing/401(k) Council of America: “48th Annual Survey of Profit Sharing and 401(k) Plans”.

Prudential Financial research on long-Term care, April 2006.

Social Security Administration (2005): 2006 Social Security Changes, Cost of Living Adjustment, October.

Social Security Administration: Answers to Your Questions.

Social Security Administration: Overview of the Social Security Administration.

Sondergeld, E. (2005): “Public Misperceptions About Retirement Security”, LIMRA, February.

U.S. Dept. of Health & Human Services Administration on Aging (2003): “Statistics: A Profile of Older Americans” (updated 9/9/04).

WatsonWyatt Worldwide (1999): Executive Summary, “Phased Retirement — Reshaping the End of Work”.

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