Retirement Income Planning Is Misunderstood

Workers may need help in understanding how to develop viable plans for lifetime income. 

A survey has found that many workers misunderstand key retirement income issues—sending a signal to plan sponsors that they should aim to improve participants’ knowledge of certain financial and economic concepts.

The Insured Retirement Institute survey, “Retirement Readiness Among Older Workers 2021,” promoted as part of April’s Financial Literacy Month, found that 26% of respondents correctly estimated the amount of annual income that they would need in 10 years, accounting for a yearly 3% rise in inflation, to maintain their current standard of living.

“Understanding the erosive effect of inflation on spending power is critically important for planning to enjoy a secure retirement,” says Frank O’Connor, IRI vice president of research. “Consumers need to understand the importance of having a portion of retirement investment portfolios in risk assets that have a better chance of keeping pace with inflation than ‘safe’ investment options.”

O’Connor explains that participants allocating a portion of their retirement savings to annuities can provide themselves a steady stream of protected income for each month of their lives to cover essential expenses, with another portion of savings invested to generate growth. 

IRI also found that less than 30% of respondents correctly calculated the monthly income that can be safely withdrawn from an investment portfolio.  

“Failing to understand the amount of monthly income that retirement savings can generate could lead to overly optimistic retirement income expectations and hasten the depletion of retirement funds,” O’Connor says. “This also points to another benefit of annuities: using a portion of savings to lock in lifetime income is a disciplined way to deploy assets and guard against overspending.”

For inflation protection, plan sponsors should consider including exposures to a mix of asset classes, both within the suite of target-date funds and on the investment menu, that can help participants’ accounts keep up with rising costs.

Participants also misconstrue sequence of returns risk, the survey revealed: Nearly 70% of respondents did not understand that when one is taking regular withdrawals for retirement income, it is preferable to experience a significant market correction late in retirement versus near the outset, according to IRI.

“Failing to consider sequence of returns risk immediately before or at the early stages of retirement could have a significant negative long-term impact on retirement savings that ultimately results in the exhaustion of financial assets while income is still needed,” O’Connor says.

Survey respondents showed better understanding when asked about the average Social Security monthly retirement benefit, as 42% answered correctly with $1,500 per month. However, 40% overestimated the average monthly benefit.

Workers would benefit from talking with a financial adviser to correct misperceptions and develop a strategy to maximize benefits, O’Connor says.

“In addition to gaining a firm understanding of retirement planning essentials, consumers should engage with a financial professional to develop a retirement plan with strategies for generating protected income that cannot be outlived,” he says.