Boomers and the generations that are following them are demanding and using tools to pursue meaning later in life more than ever before--creating and actively contributing instead of turning into passive consumers as they age. Rather than accumulating an arbitrary sum for retirement and spending it down, more people want to be able to meet their financial goals at every stage of life, including retirement. The result is that goal-based planning is assuming increased importance for every generation, as is planning for income replacement during retirement.
As the average lifespan is increasing, for many people retirement is as much about how they want to spend their time as it is about spending their money. How an individual or couple chooses to live during this phase largely determines how much money they will need in retirement. So measuring ‘retirement readiness’ will become increasingly individualized, and plan sponsors may want to see whether participants are making progress towards their personalized goals, rather than an arbitrary benchmark. Since no one can save for retirement when they are burdened by debt, making progress toward the goal of financial well-being will become the starting point for retirement planning, particularly for younger workers.
Working in retirement, or unretiring
Whether by necessity, choice, or both, working at least part-time in retirement is more and more likely to be a reality for today’s plan participants. We know now that for many people, the 401(k) can’t do it all, even when combined with Social Security benefits. This is especially true for women, people of color, and single individuals; these groups all tend to have lower accumulated savings, and lower average benefit amounts. Women and minorities in particular have less income to begin with, due to gender and racial income disparities, and are at a disadvantage when it comes to saving for retirement, according to the Pew Research Center. And for younger workers, what Social Security will look like as they approach retirement is unknown.
Continuing to work part-time or full time after reaching full retirement age provides several advantages to older workers. First, under current law they can begin to draw Social Security benefits without penalty, if they choose, or delay drawing Social Security up to age 70, which increases their future monthly income. For plan participants born after 1943, every year past their full retirement age that they delay applying for benefits increases their benefit amount by 8%. While plan participants cannot make traditional IRA contribution past age 70½, working at least part-time allows them to continue contributing to an existing 401(k) or Roth account, subject to income restrictions. And of course, delaying the drawdown of retirement assets allows them to compound longer.
Continuing to work for even a short amount of time past 65 can have a surprisingly large impact on income in retirement. According to a new working paper by the National Bureau of Economic Research, using data from the Health and Retirement Study, the authors found that working just three to six months longer has the same result as saving an additional one percentage point of earnings for 30 years. Working just one month longer has the same effect as increasing retirement saving by one percentage point for 10 years before retirement.
There are multiple ways to increase income in retirement (or earlier) besides working for a large employer or small business. With the rise of the sharing economy and the increasing popularity of the side hustle, people can earn money by driving their car or renting out a spare bedroom, monetizing a hobby, teaching a skill, offering freelance services, or providing consulting in an area of professional expertise. Having additional sources of income besides retirement savings can also reduce sequence of returns risk, a serious concern for most people as longevity increases.
Healthcare costs and HSAs
A common expense in retirement that plan participants frequently fail to consider is the cost of healthcare. One study by Fidelity estimates that the average couple should plan to spend roughly $275,000 to cover healthcare costs during retirement. Continuing to work longer may help here as well, and not only in terms of saving more. The social interactions, cognitive demands, and physical activity that working as an employee or a volunteer facilitates may offer some protective health benefits. A cause-and-effect relationship is difficult to untangle because poor health is often an impetus for retirement, and consequently those who remain in the workforce are more likely to be in good or at least adequate health.
However, research is beginning to accumulate that the social connection and cognitive stimulation provided by working or volunteering during retirement can be helpful in maintaining health. Harvard Medical School professor Nicole Maestas, in an interview for The New York Times, stated that while current evidence is mixed, “The studies I have seen tend to show that there are health benefits to working longer. What is the benefit of work? Activation of the brain and activation of social networks may be critical.” In addition, research by AARP on a national project involving 2,000 volunteers across 20 cities noted both physical benefits and cognitive improvement in people over 50 who volunteered in schools.
Regarding healthcare costs in retirement, HSAs are likely to assume increased importance as higher healthcare costs are passed on to plan participants. HSAs offer a triple tax advantage--contributions are tax-free, compound tax-free, and are tax-free when withdrawn. Yet many plan participants and sponsors remain unaware of the advantages HSAs provide and often confuse their rules with those of FSAs, assuming that any money contributed to an HSA must be spent by the end of the year or else it is lost. One additional benefit of HSAs, for those who qualify for them, is that unlike a FSA that disappears when an employee changes jobs, a HSA remains with the employee and can be carried over to a new job. Younger workers should especially be encouraged to contribute to HSAs, because their savings can have longer to grow and compound, and are not dependant on remaining with the same employer. And, HSAs can be especially important for those who switch to part-time work or retire altogether sooner than expected because of health issues.
Advisors can play an important role in educating plan participants about the advantages of HSAs. Managing investments in HSAs is a natural extension of managing a company’s retirement plan, and offers an opportunity for advisors to add value as well as assets. HSAs currently hold $45 billion dollars nationally, an amount that is largely in cash and is estimated to increase to $69 billion by the end of 2019.
To read more about the changing retirement narrative, click here.