Boomers may outlive their 401(k) savings — unlike predecessors with pensions

Baby boomers are prone to quickly spending down their retirement savings — and they might outlive them, according to a new study.

The findings from the Center for Retirement Research 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 boomers’ predecessors, who drew down their nest eggs very slowly. Boomers, however, mostly use defined contribution accounts, such as 401(k)s, and already appear to be cashing out much faster.

“What we can see is that really, they do draw down faster than prior generations,” said Gal Wettstein, one of the report’s authors.

The study found a strong correlation between traditional pension plans and longer-lasting savings. Retirees starting with $200,000, for example, were found to retain $28,000 more of their wealth by age 70 if they had a pension, compared to those without one.

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Wettstein called the results surprising. Defined benefit plans typically guarantee an income for the rest of one’s life. So someone in a 401(k) plan, without that guarantee, might be expected to save more carefully. But that wasn’t the case.

“That should have made people save even more, or draw down more slowly, because they would have been extremely concerned about running out of assets,” Wettstein said. “But that isn’t what we see. We see that people who have DCs tend to draw down their assets faster than people with DBs.”

The center is not the only organization to see trouble ahead. The Insured Retirement Institute has noticed the same problem with defined contribution accounts in its research.

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

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

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

“A common misperception people have is that if they need long-term care, it’ll be covered by Medicare,” O’Connor said. “It’s not.”

Some of the institute's surveys have asked boomers what they would do if their savings don’t last. Respondents have floated a number of solutions — relying on Social Security, cutting back on their lifestyles, even turning to children or church services for help — but O’Connor said few of them hold up to scrutiny.

“By and large, people have some pretty unrealistic expectations for what their options might be if they run out of money,” O’Connor said. “The ‘I’ll figure it out’ options are not viable.”

As Wettstein pointed out, the effects of this drawdown could hurt not only baby boomers, but the later generations who stand to inherit their wealth — or what remains of it.

“I think it's too soon in terms of the life cycle of the baby boomer generation to see what happens to their inheritances,” he said. “But I think if it is the case that they end up outliving their savings or drawing down a lot of their savings, that would impact what they have left over to leave for their kids.”

So what can advisers 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 retirement expenses might look like,” he said. “And that can be an uncomfortable conversation.”

Even if it’s unsettling, O’Connor said, both parties need to take a cold, hard look at the future. Clients need to know how expensive healthcare and other costs can be, and advisers need to  know what kind of lifestyle the client wants for his or her golden years. With the right investments, made at the right time, a future with enough savings to last comfortably through retirement doesn’t have to be out of reach.

Read more: Ask an Adviser: What happens if we learn a missing 401(k) plan participant has died?

Wettstein echoed this advice. In particular, he recommended that clients buy annuities and claim Social Security as late as possible.

“There are things you can do to protect yourself against outliving your assets,” he said. “The fact that your employer is no longer taking care of that for you means you need to do it for yourself.”

Most important of all, the conversation should happen as soon as possible.

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