While it is a topic most retirees hope to avoid ever dealing with, the reality is that not all retirement income plans will be successful. Whether due to a retiree’s refusal to plan, reluctance to take the advice of a professional, or simply due to unfortunate circumstances which were outside of a retiree’s control – failures in funding retirement can and do occur. In fact, financial planners routinely do Monte Carlo projections for retirees to determine their prospective probability of failure, especially given growing awareness of sequence of return risk.
Yet given the reports of low levels of both objective measures of retirement preparedness (such as savings) and subjective measures of retirement preparedness (such as retirement confidence), many financial advisors may be surprised to learn that bankruptcy rates among those over age 65 appears to be less than 3 per 1,000, and actually declines among older retirees. So, what’s going on? If retirees are living longer than ever – which should be making retirement more difficult than ever to afford and sustain, especially given the long-term impact of sequence of return risk – then where are all of the bankrupt retirees?
In this guest post, Derek Tharp – our Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University – examines bankruptcy among retirees, finding that the reality is that bankruptcy may not be a great indicator of retirement income planning failure. A retiree who blows through their nest egg doesn’t necessarily end up bankrupt, they simply need to adjust their spending downwards to their new reality. Social Security plus public assistance represent the true consumption “floor” for most. Further, bankruptcy may not even be a great indicator of actual financial strain, as given the rules surrounding bankruptcy, the ways that retirees deplete their retirement assets does not necessarily trigger an actual bankruptcy filing, especially in light of the ways in which bankruptcy laws favor those in retirement.
Nonetheless, the point remains: with longer life expectancies and struggles with retirement preparedness, especially combined with the difficult markets of the past 15 years, the retiree bankruptcy rate is shockingly low. Which suggests that the overwhelming majority of retirees facing retirement shortfalls really are able to downsize their lifestyle to avoid financial ruin when the time comes. Of course, few retirees want to risk even a major lifestyle setback in retirement if they can avoid it. Still, though, if most retirees really are capable of making spending adjustments when necessary… shouldn’t those potential adjustments be better reflected in financial plans in the first place?