The latest analysis from the Center for Retirement Research (CRR) at Boston College asks the critically important but difficult to answer question, “Will the financial fragility of retirees increase?”

To answer the question researchers first examine the share of expenditures that a typical elderly household devotes to basic needs. Next they review evidence on the ability of today’s elderly to absorb two major shocks—namely, a spike in medical expenses and a decline in income when widowed. Finally, researchers consider the dependence of today’s and tomorrow’s elderly on personal financial assets—particularly 401(k)s and other retirement accounts—mapping anticipated dependence against the sufficiency of assets. 

At a high level, researchers conclude that “most current retirees can absorb a shock.” However, they warn in no uncertain terms how future retirees are more likely to experience financial fragility, unless they dramatically reduce their fixed expenses or draw increased income from their assets.

The CRR analysis points to a number of studies to show nearly 80% of the spending of a typical elderly household is used to secure five “basic” needs, i.e., housing, health care, food, clothing, and transportation. These needs account for an even greater share of the expenditures of lower-income households, single individuals, and households that rent or have an outstanding mortgage.

“If necessary, households could cut back on entertainment, gifts, and other non-basic items, which include cable TV or a cell phone,” researchers suggest. “Spending on basic needs could also be trimmed. These figures nevertheless suggest that typical retirees cannot cut expenditures by more than about 20% without experiencing hardship.”

The research suggests that while some of today’s retirees are financially fragile, most appear able to absorb shocks without incurring hardship.

“For a small share of retirees both medical expenditure shocks and widowhood create hardship, identified as cutting back on needed food or medication due to a lack of funds over the previous two years,” the CRR finds. “Overall, only 10% of the elderly reported such cutbacks. Interestingly, though, even among households well above the poverty line, 5% reported cutbacks.”

Put simply, the study shows health declines were a clear predictor of hardship; the study also finds evidence that becoming a widow increases hardship. While most of today’s elderly seem able to withstand shocks, changes in the retirement landscape suggest that future retirees will face much more difficulty.

“First, to maintain their standard of living, they will increasingly rely on income drawn from financial assets accumulated over their working careers. This transition in the form of retirement income is largely due to the shift from traditional employer pensions to 401(k)s,” the CRR notes. “Second, not only is the form of income changing, but its overall level—relative to pre-retirement earnings—is declining. Social Security will replace a smaller share of earnings at any given claiming age. And the shift to 401(k)s suggests that many households could also receive somewhat lower replacement rates from employer plans.”

The CRR’s conclusion is that in this changing environment, retirees will face challenges in drawing an income from their nest egg that is “both sufficient and dependable” and, thus, could end up experiencing greater financial fragility.

“With the growing reliance on financial assets, deciding how best to draw down these assets becomes a more critical decision for retirees,” researchers add. “Given that very few purchase annuities, the income that retirees can get largely depends on how they invest, their investment returns, and the pace at which they draw down their savings. The 4% drawdown rule, traditionally considered ‘best practice,’ says that retirees have little chance of running out of money if they invest about half their savings in stocks and at age 65 draw out 4% of their savings, with the amount thereafter rising in line with inflation. Many experts now think that a 4% drawdown rate is too high, given rising longevity and potential declines in investment returns.”

Whatever the safe withdrawal rate and asset allocation, the risk of running out of money rises if retirees draw out more or invest a different amount in equities, the CRR concludes.