Defined contribution (DC) plans have done a good job helping participants save for retirement. But as our research confirms, retiring employees want help managing their transition from saving to spending—and they need that help now more than ever.
Why is solving for retirement income so challenging?
Individuals have less control over when they retire than they think. According to research from the Employee Benefit Research Institute (EBRI), almost half of retirees left the work force earlier than planned due to factors outside their control, such as health-related issues or organizational changes.1 To have sufficient funds in retirement, individuals must manage a wide range of complex variables:
- Market risks: Retirees who begin drawing income from their savings during periods when markets are down, or who purchase annuities when interest rates are low, may find that even the best-laid retirement plans are undermined.
- Longevity risk: No one knows how long they will live. Spend too aggressively in retirement, and an individual risks outliving their savings (longevity risk). Spend too conservatively, and they may sacrifice potential income and/or their lifestyle during retirement—and succeed only in creating an accidental inheritance for family members or others.
- Inflation risk: The cost of goods and services increases over time. While Social Security offers retirees some protection against inflation, annuity products designed to insure income tend to provide a fixed dollar amount each year for life. As a result, retirees’ purchasing power gradually decreases as they age.
- Spending variability: While many people assume retiree spending is unchanging from one year to the next, the reality is far different. Spending requirements change over time, and unforeseen life events (or medical expenses) can wreak havoc on retirement budgets.
J.P. Morgan research finds that average spending levels are higher in the early years of retirement – when retirees are more active – and then decrease over time. For example, at age 65, the average retiree needs to replace 92% of pre-retirement income to sustain their lifestyle. At age 85, the replacement income level drops to 70%.2
Moving past the annuity puzzle
Annuities have a long history of being marketed as a way for retirees to protect themselves against both longevity risk and market risk. Yet vast numbers of people choose not to buy these products. Academics and economists refer to this as the annuity puzzle—and often cite these inherent issues:
- Mortality risk pooling: If an annuity buyer is among the 50% of purchasers who die sooner than the actuaries estimate, the buyer never personally benefits: Their premiums are retained by the insurer and used for income payments to annuity owners who live longer.
While it is precisely this pooling of risk that protects individual annuity buyers from outliving their savings, the purchase itself can feel highly speculative, as if they are wagering a sizeable portion of the nest egg they spent a lifetime accumulating on outliving the actuaries’ estimates.
- Timing risk: Buying an annuity locks in the income payment amount at the time of purchase. This protects retirees from future market declines, but also prevents them from participating in market upside. This can lead to buyer’s remorse.
Addressing the need for new solutions
Increasingly, DC plan participants are demanding more help transitioning to retirement. And, they are seeing this help from their employers. In response, we see innovative approaches emerging as plans begin to address a range of important questions:
- How does a potential solution mitigate the risks and uncertainties associated with providing sustainable retirement income?
- What are the potential trade-offs that need to be considered?
- Are participants disadvantaged if they don’t use the features provided?
- Is the approach something participants can access and execute effectively?
To learn more, read Navigating the retirement income challenge, J.P. Morgan's latest research and overview of the strategies emerging to help DC plan participants translate savings into a steady flow of income throughout their retirement.