Boomers pay out 401(k)s faster than their predecessors did

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According to a new study, baby boomers tend to use up their retirement savings quickly — and they might outlive them.

The Center for Retirement Research’s findings focus on a key difference between the two core types of retirement plans: defined benefit and defined contribution. The former are traditional accounts like pensions or annuities, and they were common among the predecessors of the boomers, who worked out their nest egg very slowly. Boomers, however, mostly use defined contribution accounts like 401(k)s and seem to be paying out much faster already.

“What we can see is that they’re really siphoning faster than previous generations,” said Gal Wettstein, one of the report’s authors.

The study found a strong correlation between traditional pension plans and longer-term savings. For example, it has been found that retirees starting with $200,000 retain $28,000 more of their wealth by age 70 if they had an annuity than those without an annuity.

Wettstein called the results surprising. Defined benefit plans usually guarantee an income for the rest of life. So someone on a 401(k) plan without this guarantee might be expected to save more carefully. But that was not the case.

“That should have made people save even more or withdraw more slowly because they were very worried about running out of wealth,” Wettstein said. “But we don’t see that. We see that people with DCs tend to deplete their wealth faster than people with DBs.”

The center is not the only organization anticipating problems. The Insured Retirement Institute researched the same problem with defined contribution accounts.

“Not only do we agree, I would go so far as to say that the decline in pensions is one of the driving factors for our existence,” said Frank O’Connor, vice president for research at the institute. “We are now in a world where … pensions have been relegated almost exclusively to government and, in some cases, college jobs.”

In a 2018 study, the institute found that only 17% of private sector workers in the US had a defined benefit plan. Meanwhile, more than 40% of baby boomers said they had no retirement savings at all, and just 25% said they were confident their savings would last until retirement. Boomers are those born in the years following World War II through 1965, when Generation X emerged.

The consequences for aging seniors could be serious. The “overwhelming majority” of the private sector, O’Connor said, will rely on Social Security and their own savings for their day-to-day expenses, leaving little for emergencies. This could leave an aging population cash-strapped just when their healthcare costs are likely to be at their highest.

“A common misconception is that long-term care is covered by Medicare,” O’Connor said. “It is not.”

Some of the institute’s polls asked boomers what they would do if their savings weren’t enough. Respondents have suggested a range of solutions — relying on Social Security, restricting their lifestyle, even turning to children or church services for help — but O’Connor said few of these would stand up to scrutiny.

“Broadly speaking, people have some pretty unrealistic expectations of what their options might be if they run out of money,” O’Connor said. “The ‘I’ll find out’ options aren’t practical.”

As Wettstein pointed out, the impact of this decline could hurt not only the baby boomers, but also the later generations who will inherit their wealth – or what’s left of it.

“I think it’s too early in the baby boomer generation’s life cycle to see what happens to their inheritances,” he said. “But I think if they end up outliving their savings or using up a lot of their savings, that would impact what they have left for their kids.”

So what can advisors do to help? O’Connor recommends an early, brutally honest conversation with clients.

“I think it starts with an honest analysis and a thorough assessment of what pension spending might look like,” he said. “And that can be an awkward conversation.”

While it’s troubling, O’Connor said, both parties need to take a cold, hard look at the future. Clients need to understand how expensive healthcare and other costs can be, and advisors need to know what type of lifestyle the client desires for their golden years. With the right investments at the right time, a future with enough savings to comfortably stretch into retirement doesn’t have to be out of reach.

Wettstein followed this advice. In particular, he advised clients to buy annuities and apply for Social Security as late as possible.

“There are things you can do to protect yourself from surviving your fortune,” he said. “The fact that your employer doesn’t care anymore means you have to do it yourself.”

Most importantly, the conversation should take place as soon as possible.

“I don’t think it’s ever too early,” O’Connor said. “You have no better tool than time.”

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