From saving to spending: A second front emerges in the US retirement challenge

While accumulation has long been a focus for pre-retirees, ensuring a consistent and sufficient stream of income through retirement is now a pressing need for many.

The challenge of being financially prepared for retirement has been primarily a matter of financial inclusion and wealth accumulation. This perspective assumes that the way to meet the challenge is for every worker to access a retirement savings account and be motivated to defer a meaningful portion of their savings into accumulation-oriented funds. Now, however, a challenge that is arguably even more critical is how to ensure an adequate income stream through retirement. Meeting this challenge will require some shifts in how the financial-services sector equips workers for retirement.

Sidebar

When the prevailing mindset was accumulation, core innovations in defined contribution plans focused on increasing access and participation (auto-enrollment), raising savings rates (auto-escalation), and improving long-term investment performance (professionally managed target date funds). With these enhancements and help from a long bull market after the global financial crisis, US retirement account balances across defined contribution accounts and IRAs more than doubled over the past decade to $23 trillion. 1

Now, however, pre-retirees (those aged 50 to 64) must face another critical retirement issue: decumulation, or the process of converting savings for retirement into a consistent and sufficient stream of income that lasts through retirement. Exacerbating the challenge are several macro factors, among them rising inflation, market volatility, uncertainty about the costs of healthcare and assisted living in retirement, and a meaningful wave of early baby boomer retirements. As many as 80 percent of baby boomers may be unprepared for retirement, according to our recent nationwide surveys of almost 9,000 US households. Moreover, many prospective retirees feel that they lack assets and the financial know-how they need for a confident retirement. Against this backdrop and in light of our survey results, we see opportunities for financial services firms to offer innovations, including new retirement products and services, access to ecosystems of service providers, and intuitive and supportive digital client experiences.

US ‘pre-retiree’ households are unprepared to retire

Many pre-retirees are running out of time to accumulate sufficient retirement assets. Just over 80 percent of baby boomers may be unprepared for retirement, according to our surveys in 2021 and 2022 (Exhibit 1). The surveys asked about respondents’ financial sufficiency in retirement (asking whether households have sufficient assets to cover expected spending), 2 as well as their retirement confidence (whether they feel adequately prepared to manage their finances). Approximately 47 percent of households nearing retirement report that they have not achieved financial sufficiency, including 20 percent who are in the safety net, reliant heavily on Social Security for retirement income, and 27 percent who are financially at risk of not maintaining their working years’ standard of living. Another one-third of households are financially near the line, in that their assets leave little to no margin for shocks like market downturns, continued inflation, or family health changes. That leaves only 19 percent of pre-retirees likely to be fully financially secure.

More than 80 percent of US pre-retiree households are financially unprepared for a secure retirement.
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Moreover, many prospective retirees say they lack the financial know-how for a confident retirement. Of the one-third of pre-retirees financially near the line—with just enough assets to support retirement—half express a lack of confidence in their readiness for retirement. For this group, there is little room for error in the event of a market downturn, persistent inflation, or higher expenses (for example, due to chronic or end-of-life illness). People in this group would most benefit from greater certainty over how to manage their future spending, access to longevity protection, and tax-optimized withdrawal strategies.

Among the 47 percent of pre-retirees who indicate that their households lack sufficient assets to retire securely (the two lower rows in Exhibit 2), two-thirds express appropriate concern over their readiness for retirement. The remaining one-third—those who are less concerned about retirement—show a greater willingness than other segments to tap into home equity. Households in these segments will need to come up with a plan quickly, likely including drastic lifestyle spending cuts pre- and post-retirement. Some may decide to delay retirement.

Only 13 percent of US pre-retirees are ‘retirement ready’ in both financial sufficiency and confidence.
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Even among the 19 percent with sufficient assets to be financially secure, a third remain concerned about having enough for retirement, saying they feel “not ready” for and “concerned” about their future retirement. These attitudes may lead them to be overly conservative: underspending in retirement or holding too high a percentage of their savings in cash in an inflationary environment.

In this financially sufficient but not confident segment, many consumers have prepared or are actively preparing for retirement: 49 percent say that in the last five years, they undertook at least three retirement review activities such as engaging a financial adviser or learning about financial planning. This subset has an urge to preserve assets, driven by fear, consistent with what the retirement industry has dubbed the “retirement consumption gap,” where households make drastic cuts in spending that are probably unnecessary and potentially unhealthy.

An accelerating retirement challenge

Sidebar

Baby boomers are likely the generation most affected by the shift away from a defined benefit system, which provided a paycheck-like decumulation experience in retirement. The defined contribution system that largely replaced defined benefit plans has long been predicated on the assumption that retirees’ financial needs in retirement will be satisfied by consistent accumulation in employer-sponsored retirement plans during one’s working years, followed by out-of-plan decumulation solutions in retirement combined with the public-sector backstop.

That emphasis on wealth accumulation may be one reason why the baby boomer generation is estimated to control over half of US financial assets: $29 trillion out of a $55 trillion total. 3 Despite this massive asset base, however, the state of retirement readiness has become increasingly concerning. We see three factors, all of them accelerated by the COVID pandemic, making retirement readiness a greater challenge:

  1. A large wave of early retirements. The Federal Reserve estimates “excess” retirements of 2.4 million baby boomers during the pandemic months of March 2020 to August 2021. 4 Our research suggests that the biggest catalysts were the need to focus on providing healthcare to a family member (cited by 30 percent of retired respondents) and the realization that there is more to life than working (23 percent). In addition, another 57 percent of pre-retirees are now looking to accelerate their retirement dates. These early retirees and pre-retirees are forgoing critical savings in their later working years, likely drawing Social Security earlier on average, and increasing the risk that their assets will not support them through the length of their retirement.
  2. A rapid rise in inflation. Inflation in household staples (gasoline, shelter, food, and other household goods) has outpaced wage growth by two to three percentage points since early 2021. Rising prices raise the bar on savings prior to retirement, boost costs for those in retirement, and reduce the real returns of fixed-income investors over the near to medium terms, depending on their underlying holdings. Inflation is the second most cited top financial concern identified by survey respondents (cited by 20 percent), ranking just below medical costs for serious illness or accident as their biggest financial concern (one-fourth of respondents) and ahead of market volatility (20 percent). Not surprisingly, 38 percent of pre-retiree respondents express concern about outliving their assets and plan to reduce spending by at least 15 percent during retirement.
  3. Challenges around long-term care. A majority of survey respondents acknowledge worries about the cost of assisted living. Moreover, according to the National Council on Aging, about 60 percent of older adults would not be able to afford more than two years of consecutive long-term care. The long-term care challenge was revealed to be more acute during the pandemic. 5

How financial services providers can improve retirement readiness

Over the last two decades, the retirement industry has largely focused on simplifying and improving how households save and invest. As a result, a host of accumulation solutions are available in the market today, with target date funds being the most prevalent. Decumulation is another story: the breadth of products is limited, take-up rates are often low, and engagement occurs outside the workplace for many savers.

Financial services firms not only can help drive higher retirement readiness of employees within the workplace but also can help households coordinate their use of “retail” products (wealth management or banking) and “workplace” products, such as group insurance or a 401(k). The target-date fund adage of “set it and forget it” no longer applies to baby boomers who are nearing the end of the accumulation phase. Making sense of their financial lives across accounts is a core need, and financial services firms across sectors can compete to play the role of integrator.

However, financial services firms cannot be all things to all retirees, especially as baby boomers represent $29 trillion of total investable assets. The financial-sufficiency segmentation from our survey is a helpful starting point for differentiation: The segment deemed most likely to be financially secure—households that together own $17.5 trillion of investable assets—is mostly well served today by wealth managers and insurance carriers. These providers earn higher margins, and their clients have fewer unmet needs but can benefit from tailored solutions and access to a broader range of offerings.

In contrast, the “near the line” and “at risk” segments (which together own assets of $11.5 trillion) are often underserved today with respect to wealth, health, and protection. Product innovation and enhanced personalization can offer access to these segments, an opportunity especially for workplace providers and banks. The “safety net” segment, with assets of just $100 billion, will continue to require assistance from public and social programs but may still be addressable, especially if some of these people continue to work later in life.

To help solve the decumulation challenge, we believe three core areas of innovation are open to financial services firms: confidence-boosting products and services, access to ecosystems of service providers through partnerships, and improved digital client experiences.

Advice and decumulation solutions can boost retirement confidence

Leading into retirement, employers and financial services firms can provide access to advice and planning through two solutions:

  • Personalized advice as employee benefit. Digitally enabled, low-cost, personalized retirement advice is a requisite for the on-the-line and at-risk segments—and it can be offered to all employees. Our research shows that pre-retirees with an adviser or financial plan are five to ten times more likely to feel ready for retirement. Not surprisingly, the percentage of advised households is highly correlated with wealth, and at-risk households remain largely in the dark: only 17 percent have a financial plan.
  • Employer-provided retirement advice for non-executive employees. Financial-wellness education programs are often geared to new or younger employees, while personalized retirement advice for older non-executive employees is scarce. While digital or remote retirement planning can and should exist outside of the workplace, employer-provided advice is a natural way to reach more at-risk households who depend on the workplace for the accumulation phase.

At retirement, households need simple conversion products and experiences to help convert retiree balances into new cash flows:

  • Curated annuities with institutional pricing offered at retirement. Similar to what federal employees receive through the Thrift Savings Plan, companies can offer a seamless annuitization experience to convert retirement savings into guaranteed income. This can help many employees nearing and at retirement—for example, by leveraging default architecture in the plan to automatically convert a portion of the balance into an annuity structure leading up to retirement. In fact, recent changes to Department of Labor laws 6 mark an important first step in liberalizing in-plan retirement options. In our research, guaranteed-income products had a strong appeal, especially to the at-risk segment.

    For annuity manufacturers, growth will require overcoming the current awareness and education challenge: 31 percent of the financially secure pre-retirees and retirees we surveyed say their top reason for not owning an annuity is “I don’t really understand annuities and how they work,” and that share rises to 45 to 50 percent for less secure segments. In addition, pricing structure and the minimum asset threshold also present a challenge, with 25 to 30 percent of respondents citing “annuities are too expensive” as the second top reason for not owning an annuity. This renders digital and technology innovations critical for democratizing these offerings.
  • “Decumulation robos” that make tax-smart withdrawals. At-risk and on-the-line households will likely have little to no money to spare in retirement. For them, digital management tools that prompt tax-optimized withdrawals from various retirement accounts, including 401(k), IRA, brokerage, and savings accounts, can create substantial value. A paycheck-like experience, where a retiree receives a monthly payment, also can help people stay on track while reducing the risk of underconsumption. In addition, retirees will still need to stay invested for two decades on average, so retirement robos can add value through appropriate asset allocation. Ideally, these tools would evolve to provide retirees with a single view into their balance sheet and cash flow statements to give them greater confidence in their plan. In addition, trust building, potentially through additional access to remote advisers, might help augment retirees’ comfort with this type of solution.

Ecosystem partnerships can help retirees manage spending

In addition to product development, financial services providers may find attractive opportunities to build or join a marketplace for addressing a holistic set of retirement needs—for example, healthcare, senior living, insurance, and transportation—and helping retirees optimize spending to meet those needs. Increasingly, clients may look to retirement services providers to help manage spending across a range of needs.

  • Get it at “wholesale.” Ecosystems and partnerships can help retirees access and buy what they need at institutional prices with a simple experience, similar to voluntary benefits for employees or other online marketplaces. Retirees’ longevity brings a new set of complex risks, such as access to caregivers and rising costs of healthcare and housing. To help mitigate these risks, financial services firms can consider innovative M&A and partnerships to add capabilities, and they may organize and orchestrate retirement ecosystems as one-stop shops that simplify retirees’ spending decisions while passing on to them the benefits of scale.
  • Holistic advice. Traditional retirement firms—including asset managers, insurers, wealth managers, and banks—can provide holistic advice that goes beyond financial transactions and planning. Increasingly, based on survey responses, we find that clients are seeking from their financial services providers advice and services on recreation, housing, healthcare, and end-of-life care. This privileged position, often earned over a 20-year accumulation relationship, can be leveraged to boost confidence in retirement.

Digital client experience and modern technology do more for less

Across the retirement sector, financial services firms have started developing improved technology capabilities to harness data and analytics, enhance customers’ digital experiences, and ultimately deliver better client outcomes. Firms that offer pre-retirees a curated marketplace—or ecosystem—of additional services will need to ensure a seamless digital client experience supported by a modern technology infrastructure. An example of superior digital experiences is easy “employee offboarding” at point of retirement, which improves adoption and engagement, much as digital and hybrid efforts have improved annual 401(k) enrollment.

Delivering on the digital client experience is typically the role of the “ecosystem orchestrator.” In our experience, incumbent financial services firms benefit from partnering with digital natives, who can often build digital ecosystems and experiences more quickly and at lower cost. Financial services companies that choose this route should be prepared to address three key considerations:

  1. A modern technology infrastructure is needed to underpin the transformation required across products, ecosystems, and digital client experiences.
  2. Scalability and hyper-personalization of the solutions are important, especially because the on-the-line and at-risk retirement populations are underserved by in-person models. With data analytics, retirement providers can get closer to knowing which individual is open to what product at what time and through what combination of channels. Analytics and data tools are already delivering new insights that are helping retirement providers create innovative products. Moreover, advanced analytics can be deployed to make transactions more customer friendly.
  3. Seamless integration across retail and workplace accounts can allow withdrawals from the 401(k) in a smart way, integrated with other retirement and financial accounts.

Significant new challenges affect more than 80 percent of US pre-retirees. Knowledge of this should spur action, innovation, new-business building, and transformation in the retirement services industry. While the challenges of serving pre-retirees are acute, the industry is up to the task. Opportunities are there for those who will boldly pursue new approaches across products and offerings, ecosystem partnerships, and digital client experience.

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