The looming longevity crisis

Back when Social Security was created in 1935, the average life expectancy in the U.S. was only 61 years, and just 6% of Americans were age 65 or older. The good news? Today, 15% of us are 65+, and that number is expected to pass 22% by 2050.

Not only are more of us living to see retirement, but retirements are getting much longer.  In 2000, there were 50,281 centenarians—people who live to 100—in the United States. In 2014, that number was 72,197, and by 2050 there will be 378,000 Americans age 100 or over, according to the Pew Research Center.

Americans are living much longer than we used to, but that’s only half of the story. We’re also having fewer children: women born in 1935 had an average of three children, and today that number is 1.9. The Census Bureau predicts that just 11 years from now, there will be more senior citizens in America than people under 18.

So what’s the problem?

It really is great news that people are living longer, but an aging population has some pretty severe side effects when it comes to retirement. In 1960, there were over five workers for every retiree receiving Social Security, but by 2040, the ratio will be close to two workers per retiree. The vast majority of Social Security’s funding comes from payroll taxes (88% in 2017), so the fewer workers there are paying in, the harder Social Security is to fund.

The Social Security and Medicare Board of Trustees reports that the Social Security trust will be exhausted by 2034. After that, payroll taxes will only support 79% of promised benefits for 2034, and the problem grows worse from there. This doesn’t mean Social Security is doomed, but it does mean retirement planning can’t be put off indefinitely.

The other problem: disappearing pensions

Company pensions used to be a standard benefit in America, but since the advent of the 401(k), they’ve steadily declined in the private sector. That’s unfortunate, since 401(k)s shift two distinct risks from the employer to the individual: investment risk and longevity risk.

As anyone who tried to retire in the mid-to-late 2000s knows, the stock market can be volatile. That’s fine if you have 20 or 30 years to wait for a rebound, but not so helpful if you need the money today.

Pensions also provide a perfect hedge against longevity risk. In a given group, some people will die young, some will live an average lifespan, and some will live much longer. Pooled pension funds are like a form of insurance, where the risk of outliving one’s resources is distributed among the wider group, ensuring the money goes where it’s needed most.

The rise of the 401(k) means individuals are responsible for their own retirement, and Americans aren’t saving nearly enough to account for decades of life after their incomes stop. Among families aged 56-61, the average savings is just $167,577, according to The Economic Policy Institute.

And $167,577 is the average, which isn’t necessarily representative of the average family, since a small number of high net worth individuals skew the mean upwards. Many, many families approaching retirement age have little to no savings whatsoever, which is clear when you look at families in the middle, rather than the average. Among 56- to 61-year-olds, the median retirement savings is just $17,000, according to the same Economic Policy Institute report.

TL;DR: We’re living longer, having fewer children, saving little, and don’t have pensions. That’s a dangerous combination.

There is a solution… sort of

Even though pensions are becoming an endangered species, there are options on the market that more or less replicate their benefits. The simplest solution would be to use a chunk of your retirement savings to buy a lifetime income annuity. These annuities guarantee lasting and dependable retirement income, and solve both the longevity risk and investment risk issues for individuals.

So if pensions are great and income annuities simulate most or all of their benefits, what’s the problem? Why don’t people just create personal pensions as a standard part of retirement?

First, income annuities aren’t for everyone. If a 65-year-old woman has $50,000 saved for retirement, using it to buy a single premium income annuity (SPIA) would only net around $250 a month at current rates, which isn’t enough for even basic necessities. She’d also be left with nothing in case of a medical or other financial emergency. Clearly that’s not an ideal solution.

But there are millions of people at or near retirement age for whom income annuities do make good financial sense. Still, few of them are buying, with annuities accounting for less than 10% of America’s retirement assets. That may be partially due to the desire to leave an inheritance to loved ones, but annuities are underused even among retirees with no heirs.

A study by researchers at UCLA and Duke University investigates why annuities are less popular than many economists think they should be. In the study, survey subjects’ income, marital status, sensitivity to risk, and financial know-how were measured. Surprisingly, none were predictive of how willing someone was to purchase an annuity.

The variable that was predictive? Fairness, or rather one’s sensitivity to it. With a standard income annuity, if a person dies immediately, the insurance company keeps the money. (In reality, the money from people who die early is used to pay for those who live a long time, but it’s the perception that matters.)

It’s unfortunate that so many have an inherent aversion to sharing longevity risk, since it would be in most people’s best interests. That becomes apparent when you think of it in terms of insurance, rather than an investment. Few people will suffer a catastrophic house fire, but homeowners insurance is still a good idea. After spending time getting deep background on the issues, we started thinking about new solutions to the problem, and created AgeUp as part of the answer.

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