And now for a financial update: For the year ending September 30, the cost of future lifetime retirement income has outpaced increases in retirement savings balances. That’s left many pre-retirees with lower estimated retirement income despite strong market growth over the same period.”
If that does not sound like a market update you’ve heard before, you’re not alone. You’re probably asking what does the cost of lifetime retirement income mean. Is it really something that can be quantified and tracked? And why should it be?
You may be surprised that the update is a reasonable paraphrase of a newly released quarterly update that describes changes in the BlackRock CoRI™ Retirement Indexes (“CoRI Indexes”). The CoRI Indexes were introduced in June 2013 to help pre-retirees estimate and track the cost of future retirement income, which we believe is as potentially meaningful as stock market indicators to their future financial security. Now with over a year of published index data to examine, we can begin to look at retirement income in new ways.
But first, we need to answer a few questions:
What is retirement income?
For our purposes, let’s define retirement income as any method of obtaining a stream of income from a retirement account savings balance. We’ll exclude other sources of retirement income not dependent on your savings, such as Social Security.
Why should income “cost” me anything?
If you buy an income product, such as an annuity, you are paying a third party to assume longevity, market, interest and inflation risks on your behalf. (In other words, they are contracted to pay you for as long as you live, regardless of what the market does.) Even if you have no interest in an income product, we believe that estimating the cost of buying retirement income can help clarify your planning.
How does it help clarify my retirement planning?
It gives you something to measure your retirement drawdown strategy against. For example, if your estimated retirement income is much lower than you anticipated, you may need to reexamine your plans. It can also help you estimate how much you need to save in order to obtain a certain income level.
How do the CoRI Indexes estimate the cost of retirement income?
The CoRI Indexes are calculated using many of the same factors insurance companies and institutions use in pricing lifetime income, including interest rates, morality tables, cost of living adjustments and market risk. You can find more details about the calculation here.
Lessons Learned in the Q3 2014 Report
So what have we learned? Perhaps the biggest takeaway for pre-retirees is that the relationship between asset growth and retirement income is far more complicated than it appears.
For example, for the year ending September 30, 2014, the median retirement savings balance for a 55 year old rose 16.5%1, largely due to strong market growth. At the same time, the estimated retirement income cost for a 55 year old increased from $12.76 per dollar to $15.12. The net result is they can expect less retirement income despite the asset growth:
As of September 30, 2013:
|
Retirement Balance |
CoRI Index Level for 55 Year Old |
Estimated Retirement Income (divide balance by CoRI Index level) |
|
$1,000, 0000 |
$12.76 |
$78, 370 |
As of September 30, 2014:
|
Retirement Balance (Increased by 16.5% ) |
CoRI Index Level for 55 Year Old |
Estimated Retirement Income (divide balance by CoRI Index level) |
|
$1,160, 0000 |
$15.12 |
$76, 720 |
|
|
|
Difference: -$1650 |
The major driver of the increased cost of retirement income is that yields on 10-year Treasury notes fell over the year, from 2.64% to 2.52%. This change affected pre-retirees in their 60s less, who saw their market driven savings growth outpace the rise in retirement income costs, leaving them in relatively better shape than their younger peers.
It is counterintuitive that your retirement savings balance can increase while your retirement spending power decreases. That is one of the reasons that by tracking retirement income costs, you can develop greater clarity in your retirement planning.
1Per the Employee Benefit Research Institute (EBRI), and includes investments in both 401(k) plans and individual retirement accounts (IRAs).
Chip Castille, Managing Director, is head of the BlackRock US Retirement Group. You can find more of his posts here.