RETIREMENT RESEARCH January 2019, Number 19-1 WHAT FINANCIAL RISKS DO RETIREES FACE IN LATE LIFE? By Matthew S. Rutledge and Geoffrey T. Sanzenbacher* Introduction Rising life expectancy means that many more Ameri- to these risks. The second section explores the nature cans will reach very old ages. While longer lives are of the three risks outlined above. The final section undeniably positive, they also mean that more people concludes that out-of-pocket medical expenses, finan- will face late-life financial risks for which they may be cial mistakes, and widowhood tend to severely impact unprepared. These late-life risks include high out-of- the finances of only a minority of older Americans pocket medical expenses; an increased possibility of today, but that those threats may be more widespread financial mistakes due to declining cognitive abilities; in the future. and the specter of widowhood. The situation is generally expected to become more challenging, because future retirees will be Background more reliant on often-modest 401(k)/IRA lump sums rather than the automatic lifelong payment stream of Understanding the financial risks faced by Ameri- a traditional pension plan. At the same time, a rising cans ages 75 and over – a population that is projected Full Retirement Age means monthly Social Security to more than double by 2040 (see Figure 1, on the checks will provide less relative to pre-retirement next page) – is important for two reasons. The first income at any given claiming age. In short, future reason is that physical and mental health problems retirees will likely have less reliable income as they become much more pronounced at these ages, mean- reach advanced ages. ing that people run the risk of draining their savings This brief reviews research by the U.S. Social Se- through high out-of-pocket medical costs or finan- curity Administration’s Retirement Research Consor- cial mistakes. The second reason is that people will tium and others on the nature and extent of late-life increasingly face these challenges with 401(k)s, which financial risks. The brief is organized as follows. The provide lump sum assets that may be hard to manage first section explains how demographic and economic with age, especially since initial balances tend to be changes are leading to a larger population susceptible modest. * Matthew S. Rutledge is an associate professor of the practice of economics at Boston College and a research fellow at the Center for Retirement Research at Boston College (CRR). Geoffrey T. Sanzenbacher is associate director for research at the CRR. 2 Center for Retirement Research Figure 1. Current and Projected U.S. Population ing to the Social Security Administration, a woman Ages 75+, 2016-2040 (in Millions) age 62 today has a 20-percent chance of becoming a widow by 75 and a 33-percent chance by 85.2 In 50 other words, as people age, the risks to their physi- 45 45 cal health, mental health, and their spouse’s health 40 40 increase dramatically. 34 On the financial front, the growing group of older 35 30 29 retirees facing these physical and cognitive health 23 risks will be much more reliant on 401(k) plans, 25 21 which provide a lump sum, than on traditional pen- 20 sions, which provide a stream of income (see Figure 15 3). DC plans are harder to manage with age, in part 10 because individuals must decide how best to draw 5 down their nest egg. 0 2016 2020 2025 2030 2035 2040 Figure 3. Workers with Plan Coverage by Type of Source: U.S. Census Bureau (2017). Plan, 1983, 1998, and 2016 80% 73% 1983 On the health front, the share of individuals who 1998 have difficulty performing basic Activities of Daily 62% 60% 2016 Living (e.g., bathing or eating) or more complex 60% Instrumental Activities of Daily Living (e.g., cooking or shopping) increases dramatically after age 75 (see 40% Figure 2). These conditions can require professional in-home care or even long-term care at an institution- 24% 26% al facility, both of which are often expensive. 17% 16% 20% 12% 10% Figure 2. Percentage of Population with Activity 0% Limitations by Age, 2014 Defined benefit Defined Both only contribution only 20% 19% ADLs Source: Munnell and Chen (2017). IADLs 15% Of course, risks to retirees’ financial health in old 11% age would not be a major concern if people arrived at retirement with sufficient wealth and were unlikely 10% to run out. However, few have large nest eggs; the 6% typical household nearing retirement with a 401(k) today has only about $135,000 in 401(k)/IRA assets, 5% 4% 4% which – even if annuitized – would only provide about 2% $600 per month.3 And that number is for people with 0% a plan; nearly a third of all households nearing retire- 45-64 65-74 75+ ment have no retirement savings. In addition, Social Security replacement rates are declining at any given Source: Centers for Disease Control and Prevention, Na- claiming age due to the increase in the Full Retire- tional Health Interview Survey (2014). ment Age. In other words, the future will see an in- creasing number of older retirees relying on relatively The incidence of cognitive decline also begins small 401(k) balances and on Social Security checks rising after age 75, with the rate of dementia growing that do not stretch as far. The question is, what does quickly from 7 percent for people in their early 70s to existing research tell us about the risks that retirees roughly a quarter for those in their early 80s, raising face in late life? the risk of financial mistakes or fraud.1 And, accord- Issue in Brief 3 Late-Life Risks Figure 4. 90th Percentile of Out-of-Pocket Health Spending as Percentage of Total Income Researchers involved in the Retirement Research by Age, 2013 Consortium identify three risks to financial health in 160% late life posed by: 1) out-of-pocket costs for both stan- 142% dard health care needs and long-term care; 2) cogni- tive decline leading to mistakes; and 3) the prospect of 120% widowhood. Out-of-Pocket Medical Costs 80% 56% Even though Medicare provides universal health cov- 42% erage to retirees, out-of-pocket costs can still pose a 40% substantial burden for elderly households, even prior to any need for long-term care. Medicare enrollees pay premiums for Parts B and D and any supple- 0% mental coverage; contribute a portion of the cost of Ages 65-74 Ages 75-84 Ages 85+ Medicare-covered services they receive through copay- Note: These data include standard health care costs and ments and deductibles; and face the full cost of the long-term care costs. many services not covered by Medicare (e.g., dental Source: Adapted from Cubanski et al. (2018). and vision). The question is how much these costs actually threaten financial health. A recent study by McInerney, Rutledge, and King (2017) found that, for The conclusion from these studies is that, to date, those ages 75+, these out-of-pocket costs amounted to out-of-pocket costs pose a risk to some retirees, but about 20 percent of their total income. This share is mainly to those in the tail of the distribution of costs. significant, but perhaps manageable for most house- People in the middle bear a noticeable burden that holds. However, the study points out that, for about likely crimps their standard of living, but might not 5 percent of households, these standard out-of-pocket put their finances at risk. However, analysts expect expenses eat up over half of total income, potentially out-of-pocket health costs to continue to grow faster causing them to dig into their wealth to make ends than retirees’ income, meaning that these costs may meet. have more of an impact on a larger portion of the Once long-term care costs are included, the distribution in the future.6 picture becomes slightly less sanguine. A recent study by Jones et al. (2018) estimates that the average Managing Money with Declining household – from their early 70s on – will incur about $100,000 in total out-of-pocket medical spending Cognition including long-term care, and that the top 5 percent In addition to the risk of high out-of-pocket medical of spenders will incur almost $300,000. Another costs, aging individuals can experience a decline in recent study by Cubanski et al. (2018) illustrates how their ability to manage their money, which increases this tail risk grows with age. Looking at the top 10 the risk of making routine financial mistakes and of percent of spenders, the study shows that, among falling victim to fraud. These risks will only be more older households, costs can dwarf income (see Figure acute in the future, as households’ entire retirement 4). Although Medicaid mitigates the risks of these savings – their 401(k)/IRA assets – are potentially very high amounts for the poor, for those with 401(k) more vulnerable to an act of fraud, instead of just a wealth, who tend to be higher income, these costs can single monthly pension check. The basic issue is end up eating into their wealth.4 The saving grace is that financial skill tends to deteriorate for many in that about half of the people approaching retirement their 70s. At first, minor things start occurring, like never require nursing home care, even in old age.5 forgetting to pay certain bills.7 However, when severe This fact means that although the tail risk tends to be decline such as dementia sets in, the vast majority of high, costs at the median may be more manageable. people lose the ability to manage their finances at all.8 4 Center for Retirement Research While many individuals can get help from a non- And while Belbase, Sanzenbacher, and King impaired spouse, Belbase and Sanzenbacher (2017b) (2018) report that Social Security’s Representative point out that aging households are more vulnerable Payee program (which assigns a third party to receive to mismanagement when the financially savvy spouse and manage someone’s benefits) could be one way dies early or becomes cognitively impaired – espe- to help, it is not frequently used even by those with cially because that spouse may be unaware that he is dementia and is not designed to assist with any non- slipping until it is too late.9 Social Security income. Not surprisingly, the risk of falling victim to fraud The takeaway from these studies seems similar to rises with age. Compared to 40-somethings, seniors those on out-of-pocket expenses: the financial threat are more likely to be solicited by fraudulent invest- posed by cognitive decline is smaller today than it ment schemes, and nearly one in six seniors reported may be in the future. So far, cognitive decline has af- losing money in such a scheme.10 One reason they fected the finances of some individuals, but far from may be vulnerable appears to be overconfidence. a majority. The mitigating factor seems to be having Many seniors report being confident in their financial a source of help, and most people have it. However, aptitude, but nonetheless get basic financial literacy in the future, having such assistance will be more questions wrong. When they do, Gamble, Boyle, Yu, important, as less income comes from Social Security and Bennett (2014) find that they are more likely to be and traditional pensions and more comes in a lump the victims of fraud down the line. sum that is more vulnerable to fraud. In addition, While the financial challenges of cognitive decline tomorrow’s retirees will have fewer children to sup- clearly are cause for concern, the size of this problem port them than their parents did, and children are a to date seems to be relatively small. A key reason is primary source of financial management assistance.11 that those who do need help with their finances often get effective assistance. For example, Belbase and The Risk of Widowhood Sanzenbacher (2017a) find that about 85 percent of dementia sufferers have some form of help managing In the past, widowhood resulted in poverty for many their money, and they fare as well in avoiding se- women – but recently that risk has declined. Ac- vere financial hardships as those without a cognitive cording to Munnell, Sanzenbacher, and Zulkarnain impairment. Still, those who get no help are about (2018), the poverty rate for widows dropped from 20 7 percentage points more likely to experience severe percent in 1994 to 13 percent in 2014 due to women’s hardships such as difficulty paying for food, housing, increasing labor force participation and education. and medical bills (see Figure 5). Furthermore, that study predicts that the poverty rate for widows will continue to drop, partially because marriage has become more “selective” – higher Figure 5. Incidence of Financial Hardships by socioeconomic status (SES) individuals are more Cognitive Health Status and Availability of Aid likely to be married today than those with lower 15% SES. Although, it is worth noting that this research 12.2% Unimpaired, no assistance on poverty assumes Social Security benefits remain Established dementia, with assistance unchanged; if benefits were reduced to improve the 10% Established dementia, without assistance program’s long-term financial situation, poverty rates could worsen again. 6.2% 5.5% 5.5% In any case, poverty is an extreme measure of 5% 4.1% financial stress. A broader potential concern is how 3.0% 3.0% 2.1% 2.1% widowhood will affect the ability of women to main- 0.8% tain their standard of living in retirement. Sass (2018) 0% points out that the increasing reliance on financial Any Food Housing Utilities Medical financial bills wealth introduces new challenges that will likely hardship mean widows can replace less of their pre-retirement income than in the past. Munnell and Eschtruth Difficulties paying for: (2018) provide one counterintuitive reason for this Source: Belbase and Sanzenbacher (2017b). increased reliance – women are working more and earning more relative to their husbands. Because of Issue in Brief 5 the way Social Security widow benefits are designed – Indeed, Poterba, Venti, and Wise (2017) report a mod- with a widow entitled to the larger of her own benefit est drop in wealth for today’s women who experience or her husband’s – this change means that widows’ widowhood, although they point out that research household income from Social Security drops more based on today’s retirees – who often still have con- than it used to when a husband dies (see Figure 6). siderable amounts of annuitized wealth – may not So, while poverty may be less likely in the future for say much about the future. Consistent with the other widows, a drop in their standard of living or the need threats faced by older Americans, widowhood may to dig into their wealth might become more common. affect women’s finances more in the future than it does today. Figure 6. Widow Benefit as a Percentage of Couple’s Combined Benefit, by Ratio of Wife’s-to- Conclusion Husband’s Earnings The United States is facing a challenge – the number 100% of individuals ages 75+ is growing, and this group will be more reliant on 401(k) wealth and less on 75% traditional pensions and Social Security. This brief 67% 67% 57% focused on three risks to their financial health: 1) out- 50% of-pocket medical costs; 2) cognitive decline; and 3) 50% widowhood. The takeaway from the research litera- ture seems to be that, so far, these risks adversely af- 25% fect some retirees severely, but this outcome may not be that common. However, in the future, a growing number may experience such an outcome. The silver 0% lining is that these challenges can be seen in advance, No earnings One-third Two-thirds Equal so researchers, policymakers, and individuals them- Ratio of wife's to husband's earnings selves have time to develop and implement solutions. Note: This example assumes both spouses claim at the Full Retirement Age and the husband’s benefit replaces 40 percent of his pre-retirement earnings. Source: Munnell and Eschtruth (2018). 6 Center for Retirement Research Endnotes 1 Belbase and Sanzenbacher (2017a). 2 U.S. Social Security Administration (2018). 3 See Munnell and Chen (2017). 4 Poterba, Venti, and Wise (2017) report a modest increase in the share of married couples with less than $100,000 in financial assets following worsening health. 5 Hurd, Michaud, and Rohwedder (2017). 6 In their study, Cubanski et al. (2018) expect the share of income paid to out-of-pocket costs to grow by roughly 20 percent for Medicare beneficiaries be- tween 2013 and 2030. 7 Indeed, the Alzheimer’s Association (2018) cites forgetting to pay bills as a possible early sign of Al- zheimer’s. 8 Korniotis and Kumar (2011) and Belbase and San- zenbacher (2017b). 9 Hsu and Willis (2013) find that households often do not change management of their finances from the spouse with dementia to the unimpaired spouse until after the dementia diagnosis. 10 FINRA (2013). 11 See Belbase and Sanzenbacher (2017a). Issue in Brief 7 References Alzhiemer’s Association. 2018. “10 Early Signs and Jones, John Bailey, Mariacristina De Nardi, Eric Symptoms of Alzheimer’s.” Accessed from French, Rory McGee, and Justin Kirschner. 2018. https://www.alz.org/alzheimers-dementia/10_ “The Lifetime Medical Spending of Retirees.” signs. Working Paper 24599. Cambridge, MA: National Bureau of Economic Research. Belbase, Anek and Geoffrey T. 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National Population Pro- Households: The Impact of Information.” Journal jections Tables. Washington, DC. of Human Capital 7(4): 340-377. U.S. Social Security Administration. 2018. Longevity Hurd, Michael D., Pierre-Carl Michaud, and Susann Visualizer. Washington, DC. Available at https:// Rohwedder. 2017. “Distribution of Lifetime Nurs- www.ssa.gov/retirementpolicy/tools/longevity- ing Home Use and of Out-of-Pocket Spending.” visualizer/index.html Proceedings of the National Academy of Sciences 114(37): 277-297. RETIREMENT RESEARCH About the Center Affiliated Institutions The mission of the Center for Retirement Research The Brookings Institution at Boston College is to produce first-class research Mathematica – Center for Studying Disability Policy and educational tools and forge a strong link between Syracuse University the academic community and decision-makers in the Urban Institute public and private sectors around an issue of criti- cal importance to the nation’s future. To achieve this mission, the Center sponsors a wide variety of Contact Information Center for Retirement Research research projects, transmits new findings to a broad Boston College audience, trains new scholars, and broadens access to Hovey House valuable data sources. Since its inception in 1998, the 140 Commonwealth Avenue Center has established a reputation as an authorita- Chestnut Hill, MA 02467-3808 tive source of information on all major aspects of the Phone: (617) 552-1762 retirement income debate. Fax: (617) 552-0191 E-mail: crr@bc.edu Website: http://crr.bc.edu © 2019, by Trustees of Boston College, Center for Retirement Research. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that the authors are identified and full credit, including copyright notice, is given to Trustees of Boston College, Center for Retirement Research. The research reported herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium. The opinions and conclusions expressed are solely those of the authors and do not represent the opinions or policy of SSA, any agency of the federal government, Boston College, or the Center for Retirement Research. Neither the United States Government nor any agency thereof, nor any of their employees, make any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trade- mark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof.