Key retirement risks facing HNW Americans 

For individuals with a defined contribution (DC) retirement account, managing retirement income is a very challenging task. While a key risk is over-spending in early retirement and running out of funds too soon, individuals also risk going to the opposite extreme and underusing their retirement funds. And even the best-laid plans face the difficulty of estimating longevity, as well as issues such as the possible need for additional health or social care, or a wish to leave an inheritance. And this is without considering the recent rise in inflation, which is especially troublesome for retirees on a fixed income. 

New research by CoreData among 1,500 US individuals aged 55 and over – half pre-retirees and half retirees – shows how they are facing up to their retirement security and how well they understand their financial position. In particular, the research has raised some fascinating insights into the thoughts and actions of high-net-worth individuals (HNWIs), or those with US$1 million or more in investable assets.  

Some HNWIs are feeling insecure 

The research shows that HNW Americans are not immune to the fears and challenges of decumulation despite their wealth. For example, faced with the effects of a rising cost of living on everyday expenses, 29% of HNWIs say they have cut back on small pleasures like going out to eat, hobbies and memberships and subscriptions. This is significantly below 45% of all those questioned but is still almost 3 in ten of a wealthy group. The impact of the rising cost of living on HNWIs is further shown by the finding that 25% say their income has fallen behind the cost of living in the last year, compared to 35% of all respondents. 

Financial anxiety can also be seen when HNWIs were asked if they are confident that they have sufficient retirement savings, and other financial assets to last the rest of their life. Here, 24% of HNW retirees are not fully confident, rising slightly to 27% of HNW pre-retirees. In a similar vein, when asked if they feel they have enough money to do the things they want in life right now, only 33% of HNWI retirees said ‘all the time’, compared to 19% of all respondents.  

To examine some of the underlying issues here in more detail, CoreData modeled pre-retirees’ asset growth to retirement, then converted these assets into a lifetime income stream and compared that to their pre-retirement income to determine if respondents have adequate savings to maintain their standard of living through retirement. The research used the CBO guideline of 70% income replacement, so those on track to replace 70% to 99% of their income were rated as adequate, and those with 100% or more rated as surplus. Given the use of actual incomes as the benchmark for income replacement adequacy, HNWs with very high present incomes have commensurately high funding needs, pushing many off track in our estimation.   

Using this framework, counterintuitively, we found that half (50%) of the surplus group are cutting back on small pleasures, higher than among those who are projected to face a severe shortfall (36%), or a replacement rate of less than 50% of their current income. 

So those pre-retirees with better prospects in retirement (heading for a surplus replacement income) are actually more likely to control their spending than those with worse prospects (heading for a severe squeeze). One reason for this, which our analysis highlights, is because those in the group facing a severe squeeze in retirement are largely overconfident in their retirement security (90%+ are overconfident or have overestimated the adequacy of their replacement income), while those with expected surplus replacement income are frequently underconfident (50%+ are underconfident, or have underestimated the adequacy of the replacement income). 

The challenge for pre-retirees of accurately assessing and understanding their financial position is clearly illustrated by the finding that over half, 55%, of HNW pre-retirees are miscalibrated when comparing objective retirement adequacy against their confidence level. This is more likely to be in the form of overconfidence (33% of pre-retirees) than under confidence (22% of pre-retirees). 

The cost pressures that wealth doesn’t remove 

When all respondents were asked about the three biggest different factors that have most severely affected their retirement security, they said the rising cost of living (75%), then taxes (32%) and a healthcare shock (19%). Among HNWIs, taxes are proportionately a bigger issue (39%), a healthcare shock is slightly higher (23%), while the rising cost of living is less impactful, albeit still selected by 63%.These findings show that the biggest drags on retirement security are shared by retirees and pre-retirees in all wealth brackets.  

Are retirement plans based on questionable assumptions? 

However, the research has found that a major, if not the biggest, risk for both HNW pre-retirees and retirees is a lack of planning, or planning that rests on weak assumptions. One example of this is that when retirees were asked about how well developed their retirement income plan is on a scale of one to five, just under two-thirds (65%) have a well-developed income plan, while 23% have a basic plan or worse. 

One of the key risks that many are not adequately preparing for is the potential need for long-term care. 24% of HNW pre-retirees do not plan to purchase any form of long-term care insurance, rising to 42% of HNW retirees. When asked why, 50% of HNWIs say they have plenty of money to self-insure. But at the same time, only 56% of all HNWIs are confident that they could afford long-term care for the final five years of their life. And when asked what financial decisions they would regret if they knew they were going to live to 90 or more, the biggest regret for HNW retirees was not purchasing long-term care insurance, with 30% selecting this.  

The value of professional advice is apparent in the fact that LTC insurance uptake rates rise among those with a professional advisor, as does satisfaction with retirement income decisions.. 

HNWIs can also be particularly vulnerable to a dependence on illiquid assets in retirement according to our findings. For example, over a quarter (26%) of HNWIs are reliant on selling their home for financial security in retirement, above 19% for all respondents. And when asked how a forced sale of their home at a much lower price than they expect would impact on their financial security in retirement, a fifth (20%) of HNWIs said this would be totally devastating, again a higher figure than for the overall population (13%).  

HNWIs in the survey are also more likely to be business owners(30% vs 19% overall), with business equity appearing to be a source of financial confidence. This comes with similar risks to housing, as  be difficult to sell when needed, impacting a key source of retirement funding.  

Takeaways for financial advisers 

Firstly, some HNWIs worry they do not have sufficient assets for their retirement. While this may seem overly cautious, there are behavioral and financial reasons for this, which advisers can explore and help to mitigate. Advisers can provide a valuable service by ensuring strong alignment between objective adequacy and their retirement lifestyle and outlook. 

Another takeaway is that when understanding a HNW client’s retirement security, it is important to take account of potential drags on retirement security, such as cost of living rises, taxes and healthcare costs. Are clients planning for these factors and how has this been modelled? In addition, we can see that some HNW clients have done minimal retirement income planning and might not have considered (or deliberately avoid thinking about) long-term care costs. This means that advisers can add value with guidance and advice on these topics.  

HNW pre-retirees may also place great reliance on investments, property, or business ownership as a future source of funds. Consequently, they could be vulnerable if they are unable to achieve the sale proceeds they anticipate. Here, advisers can add value by identifying the risks of a potential shortfall, and how this can be mitigated and managed. This, and the steps outlined here, can help HNW clients enjoy the benefits of their wealth in retirement without unnecessary worry or taking undue risks with their retirement security. 

Written by Matt Craig, edited by Victoria Servave and Michael Morley.