How the BlackRock CoRI™ Retirement Indexes Change Retirement Planning
Despite decades of plan design evolution and the increased understanding of behavioral finance, the message to defined contribution participants has remained the same: save as much as you can and hope it lasts throughout retirement.
The focus in DC plans has historically been on accumulation, and many of the innovations introduced over the last decades have understandably focused on increasing savings and managing the assets. Managing the assets once in retirement, including creating a stream of retirement income from the accumulated savings, requires a different approach than the accumulation phase. Income solutions are typically not provided in-plan, leaving individual participants to explore non-plan options on their own. Unfortunately, finding solutions that balance individual preferences around cost, flexibility, liquidity and so on has been difficult.
We would also argue that there is another participant challenge that receives insufficient attention, and that’s navigating the transition between retirement savings and retirement spending. The best way to understand this challenge is through the eyes of a participant.
Imagine a 60 year old who has saved diligently for years, and now has what she considers to be a hefty savings balance. Unfortunately, she has no frame of reference for understanding what that savings balance means in the real world, post-retirement terms. How long would it last as a source of retirement spending? What amount of income can it reasonably be expected to provide and how does that compare to her current salary?
The only thing she knows for certain is her current balance, but she has no easy way of knowing if that balance is “enough”. Part of the challenge is that she is used to thinking in terms of periodic expenses (mortgage, etc.) against her periodic income (i.e. paycheck). Faced with her lump sum accumulation, she is unable to match inflows and outflows in a similar way.
The lack of clarity has consequences. She may underestimate her income potential and unnecessarily delay retirement. Or she may miss an opportunity to increase her savings effort while she has time to improve her prospects. Even if her financial position is sound, she may approach retirement in a fog of uncertainty and anxiety that could be avoided if she had some simple way to translate her savings into estimated income.
The BlackRock CoRI™ Retirement Indexes can help address that problem for her. Furthermore, the CoRI Retirement Indexes reframe retirement planning, especially for those in the last ten years before retirement. They make it possible to put meeting a retirement income goal at the heart of retirement planning.
Using the Indexes: Creating Clarity
Retirement arithmetic used to be simple, at least for those who had a defined benefit (DB) pension. Typically, DB pension income was determined through a clearly articulated formula, such as a percentage of final annual salary. Projected Social Security income was also readily available. In another era, our 60 year-old pre-retiree could add her projected pension and Social Security income together.
The monthly total was either sufficient, or it wasn’t. Either way, it was a straightforward exercise based on comparing her projected inflows against her estimated expenses.
Despite the many advantages of the defined contribution system, its focus on asset gathering provides no similar clarity about her potential retirement income. That is the specific gap the CoRI Retirement Indexes and the online CoRI tool (www.blackrock.com/cori) were created to help address. There are currently ten CoRI Retirement Indexes, one each for people 55 to 64 years old.
Our imaginary 60 year old would choose the index with the year she turns 65 in its name. So, for example, assuming she is 60 in 2014, she would choose the 2019 Index. Here she will find her daily CoRI Index level, expressed as a dollar amount –for example, $14.75. This tells her the estimated price for life contingent income beginning in 2019, the year she turns 65.
Here’s how she can use this information: Let’s assume she has $500,000 in retirement savings. She can divide that balance by her current index level ($500,000 ÷ 14.75) to arrive at an estimated annual retirement income of $33,898.30. This quick calculation gives her new insight into what her savings may translate into at 65. As we will explore shortly, the estimate essentially reflects a current price for future annuity income rather than an estimate based strictly on market assumptions. Annuity income, we believe, is a useful proxy for income estimates.
She could also use her CoRI Index Level to work backwards from a desired income to the estimated savings needed to fund it. For example, if she wanted $40,000 in annual retirement income, she could multiply that target by the current index level of 14.75 to find that she would need $590,000 in savings to meet her goal–an additional $90,000. The online CoRI tool can do these calculations for her, letting her quickly go back and forth between savings levels and targets as she explores her options. It also gives her some grounding in preparation to meet with her advisor to discuss her retirement planning.
Level Setting: Why Track Annuity Pricing?
Insurance companies have a long history of pricing and delivering annuity income. CoRI Retirement Index levels are calculated using many of the same objective factors used by annuity providers. Most importantly, annuity pricing captures factors that are very difficult for individuals to estimate in any meaningful way.
The calculation begins with the maximum estimated cash flows needed beginning at 65. Because the level expresses the cost per dollar of annual life contingent income, each cash flow is assumed to be $1. Using a standard actuarial approach, the maximum life expectancy is 115, meaning the sum of the cash flows beginning at 65, and ending at 115 is $51.00. This sum is increased by a fixed Cost of Living Adjustment (COLA). Adjusting for mortality and discounting to a present value lower the price. (See the table How Much Will Your Future Dollar Cost? for more detail.)
In order to help individuals better understand, monitor and manage their exposure to lifetime income volatility over time, we translate the index levels, which simply represent the present value of a future series of life contingent payments, into a series of bond portfolios made up of a mix of U.S. corporate and government bonds, and U.S. Treasury bonds and STRIPS. The changes in value of these bond portfolios are designed to follow the changes in annuity prices over time. The portfolio of fixed income securities that comprise each index is published daily. The CoRI Retirement Indexes, which represent a subset of the fixed income universe, are, in effect, a new asset class purpose-built to track the cost of retirement income. Each index seeks to converge to the median price for a fixed immediate annuity.
On the most basic level, however, we believe that the CoRI Retirement Indexes are a transformative step toward shifting the retirement savings focus from asset gathering to setting and achieving income goals. They can empower retirement savers with new clarity and portfolio planning capabilities during the critical pre-retirement period.
How Much Will Your Future Dollar Cost?
A dollar today costs...a dollar. But how much will it cost when you turn 65 and beyond? That's what the CoRITM Index tells you. Here are the factors that go into the calculation and how they move your CoRI Index level.
|Factor||WHY IT MATTERS|| Adjust Level |
|Stuff You Should Know...|
|Starting Level||You'll want $1 a year—every year beginning at age 65.||—||The initial CoRI Index level is established to cover the cost of annual payments through the age of 115.|
|Inflation||The cost of living will go up and you need to preserve your purchasing power.||▲||The CoRI Index level prices in an annual cost of living adjustment beginning at age 65.|
|Risk||The promise to give you a dollar in the future introduces investment risk.||▲||Current market information about what insures are charging to manage similar risk is also added into the CoRI Index level.|
|Interest||Today's interest rates can help lower the cost of your future dollar.||▼||Interest rate changes can cause daily fluctuations in your CoRI Index level.|
|Life Expectancy||Because we all won't live to 115...||▼||Your CoRI Index level is reduced using mortality calculations similar to ones used by Social Security, pension plans and insurance companies.|
|Today's CoRI Level||A simple, quick "conversation starter" for retirement planning.|