More Risk -- More Reward

Now more than ever, retirees are on their own.

Want to glimpse the future of retirement? Just ask any United Airlines (UAL ) pilot, who is staring at a cut of 60% or more in his promised pension. Ask a line worker at General Motors (GM ), who is about to lose her generous retiree health benefits. Or listen to President George Bush, who warns that Social Security is "broke" and won't be able to pay future retirees anything close to scheduled benefits.

In the new world of retirement, you'll have much less support from your former employer or from the government. You'll have to protect yourself against many complex risks -- from the danger that inflation or falling markets will eat away at your assets to the chance that you may need costly long-term care. The biggest risk of all may be that you will outlive your savings. "Self-reliance is becoming the order of the day," says University of Illinois economist Jeffrey Brown. "We are shifting more risks -- and more rewards -- to individuals."

If you make the right choices, this new world could be an improvement. You'll be able to tailor your health care and retirement package to your specific needs rather than relying on a one-size-fits-all company plan. And you won't have to fear your ex-employer going belly-up.

The troubling news is that neither workers, retirees, nor the financial world are adequately prepared. Few Americans realize how long they can expect to live, or how much retirement will cost. "People are running full speed against a brick wall," says Mary Malgoire, a financial planner in Bethesda, Md.


While financial products are rapidly evolving, few provide cost-effective security over decades of retirement. Many annuities, long-term-care insurance policies, and reverse mortgages have failed to catch on because they are prohibitively expensive or have other serious flaws.

But they will be badly needed. Within two decades, barely one in eight retirees will be getting a guaranteed pension. Retiree health insurance may disappear entirely -- just 20% of large companies offer such benefits. Out-of-pocket costs for Medicare are going to skyrocket. If you are under 50, you have little chance of collecting all your promised Social Security benefits. And states are looking to slash the nearly $80 billion they pay annually for nursing home care through Medicaid.

Governments and companies around the world are also shifting risk to individuals. The International Monetary Fund says households are becoming the "shock absorber of last resort," taking the hit when markets swoon. That stabilizes the financial system, but leaves individuals exposed, says IMF official Gerd Haeusler.

Firms are struggling to design products that provide the cash seniors need when they are hit with major health costs. For many, that will happen in their extreme old age, just when they have run through their nest eggs. Paul Fronstin, senior research associate at the Employee Benefit Research Institute, figures typical 65-year-olds will spend more than $100,000 over the rest of their lives for out-of-pocket medical costs. Long-term care can add $50,000 annually. "We need a product that will allow you to not outlive your resources," says Alicia Munnell, director of the Center for Retirement Research at Boston University.

For many retirees, immediate annuities could be a smart way to generate monthly income. They're a great deal for people who live well into their 80s or beyond. But customers shy away from them because most annuities stop paying when you die, so if you pass away at a younger age, you get a lower return.

Firms are also designing products to protect retirees from inflation, which can cut the purchasing power of a 65-year-old's annuity in half over 20 years. Yet consumers are not buying. One reason is that many retirees want more cash right away, but an inflation-indexed annuity pays less at first, in return for gradually increasing payments down the road. Says Ron Danilson, vice-president at insurer Principal Financial Group: "They may want it conceptually, until they go through the numbers."

Private long-term care insurance will also need retooling. Complexity and fast-rising premiums are keeping buyers away. Even more troubling: Many believe Medicaid will pay long-term care costs. That may be wishful thinking, but it's discouraging people from buying policies.

To boost sales, firms are looking to mix and match. For instance, Principal Financial is rolling out an annuity that increases payouts if you need long-term care. John Hancock Financial Services (MFC ) is offering a long-term-care rider to its whole-life policies. But firms need to see more consumer interest to make it worth their while. Says Massachusetts Institute of Technology economist James Poterba: "People need to appreciate their risks for the market to develop."

It isn't easy to think about money, old age, and illness. But retirees and near-retirees are coming to realize that their golden years will be very different than that of their parents. Many of us will have more opportunities to enhance our financial security in retirement. But we will have to work a lot harder at it.

By Howard Gleckman and Rich Miller

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