May 2012Perspectives

Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States
W. Van Harlow, Ph.D., CFA Director, Investment Retirement Solutions

Key takeaways

Working Americans are

on track to replace 65% of their working income in retirement.

The distribution of Lifetime

Income Scores has become more polarized, with fewer Americans in the middle and more at the bottom and the top and with more going down than moving up.

In 2011, Putnam Investments introduced the Lifetime Income ScoreSM , a tool for helping households estimate the level of income that they are currently on track to replace in retirement, in partnership with Brightwork Partners. Scores incorporate numerous variables related to earnings through employment, as well as financial behavior and confidence in financial decision making. The result is a tool that Americans can use even early in their careers to begin measuring progress toward seeking a financially secure retirement. After initially surveying 3,290 working adults between the ages of 18 and 65 in 2010 and early 2011, we have expanded and refreshed our research with a follow-up survey, which we conducted using an online panel between November and December 2011, and weighted results to U.S. Census parameters. The 3,958 working adults between the ages of 18 and 65 who responded to this survey confirmed a number of our initial conclusions regarding retirement security in America: namely, that factors such as access to workplace retirement savings programs and higher deferral rates have the most predictive value in determining retirement preparedness. Our latest survey also captures for the first time the potential contribution of home equity and business ownership to retirement income. Furthermore, our survey now contains a breakdown of Lifetime Income Scores by employment industry, and demonstrates how asset allocation outside and inside qualified retirement plans took a sharp turn in 2011 toward cash investments, primarily at the expense of equities. Lastly, our survey includes important data on workers expectations for out-of-pocket health-care costs in retirement and provides a snapshot of workers receptiveness to using health-care expense-estimating tools in conjunction with retirement planning.

Deferring 10% or more

to a workplace savings plan and using a financial advisor continue to have a major impact on retirement preparedness.

For households that expect

to add real estate equity or business value to their retirement income, scores increased from 75 to 85.

Saving for health-care costs

in retirement is gaining traction as a key investment objective.

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MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

Figure 1. Scores improved for the highest-income households

92% 2012 2011 Lifetime Income Score 80% 75% 72% 80% 74%

65%

64% 58% 61%

63%

64% 60%

62%

Total

< $50K (33%)

$50K to < $100K (41%)

$100K to < $175K (19%) Household income

$175K+ (7%)

< $100K (74%)

$100K+ (26%)

Percentages next to categories indicate incidence among respondents.

A widening gap in retirement preparedness Results from our initial survey showed that the difference in preparedness between the lowest-income earners and the top-income earners was relatively small (61% versus 80%). But our latest retirement survey provides evidence of a widening gap between lowerand higher-income households, with scores for the former generally declining and scores for the latter generally rising (Figure 1).

The median LIS for 2012 was 65, but median scores were somewhat lower (60) for household incomes below $100,000, which constitute the majority of U.S. households. The most recently released data from the U.S. Census Bureau shows that in 2010 the real median household income was $49,445, and only 20.5% of households earned incomes above $100,000.1 Counting Social Security, the difference in scores between the lowest-income earners and the top-income earners widened significantly in the past year (Figure 1), growing from 19 to 34. While saving can play a significant role in retirement preparedness regardless of income, the retirement gap between lower- and higher-income workers has clearly grown through the recent period of economic uncertainty.

Income, Poverty, and Health Insurance Coverage in the United States: 2010 U.S. Census Bureau, Sept. 2010, http://www.census.gov/prod/2010pubs/p60-238.pdf.

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Figure 2. Distribution by LIS strata

2012 0 to < 45% 29% or 2011 23%

45% to < 65%

21%

28%

65% to < 100%

22%

24%

100% or more

29%

26%

In general, we have found a rising polarization between the most prepared and the least prepared for retirement. Comparing our initial survey results with the results of our most recent survey, we find that fewer people fall into the middle tiers of retirement preparedness, but that a greater number of individuals are either in the lowest or highest tiers (Figure 2). As the share of workers with scores between 45 and 99 dropped from 52% to 43%, those scoring below 45 increased from 23% to 29% while those scoring above 100 rose from 26% to 29%. Having said that, the median score for those who came in below 45 remained relatively stable, while those who scored above 100 saw a dramatic increase in the median score, which rose from 134 to 154.

The role of demographics Along with income levels, it is no surprise that demographics continue to play an important role in determining retirement preparedness and in the calculation of Lifetime Income Scores. Our latest survey demonstrates that age, gender, education level, and employment industry are among the key demographic factors that affect retirement preparedness. Lifetime Income Scores decline as age increases. Survey results show scores dropping from 83% for those age 18 to 34, to 54% for those age 50 to 65. This relationship is likely the result of two conditions: Younger workers have longer time horizons until retirement, lower current incomes, and greater earning potential, while the oldest respondents (age 50 to 65) have fewer working years remaining and have likely maximized their earning potential. Those with the lowest Lifetime Income Scores (< 45) continue to be disproportionately women and less educated, and have lower-than-average incomes. By contrast, those with the highest scores (> 100) continue to be disproportionately men and more highly educated, and have slightly higher-than-average incomes and much higher investable assets. Over the past year, scores improved for better-educated workers with higher-than-average incomes, while scores declined for the less educated and those with lower-than-average incomes.

The difference in scores between the lowest-income earners and the top-income earners widened significantly in the past year, growing from 19 to 34.

MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

These findings concur with data showing education has a direct impact on earning potential and the ability to maintain continuous employment. According to the Bureau of Labor Statistics Current Population Survey, in 2011 those with a masters degree earned roughly twice as much on a weekly basis as those with a high school diploma, and the unemployment rate among individuals with a masters degree was 3.6%, compared with 9.4% for those who graduated high school but did not receive a graduate-level degree. 2 The significance of employment industry Recognizing that retirement plan participation is stratified by a variety of factors related to employment, we also set out in our most recent survey to determine

how specific industries compare in terms of the access they provide to workplace savings plans and in terms of median Lifetime Income Scores. Significantly, eligibility for workplace retirement plans varies widely by industry and drives Lifetime Income Scores to a large extent. Eligibility ranges from 53% in the agricultural, natural resources, and mining industries to 78% in public administration (Figure 3). Thus it is not surprising that workers in the information industry and public administration who are eligible to participate in workplace retirement plans enjoy scores of 100 and 99, respectively. Workers in these industries without access to workplace plans score in the 40s. Looking across industries, our data show that scores for workers who have access to a workplace retirement plan are about double the score for workers without access.

Figure 3. Employer plan eligibility by industry

Not eligible Public administration (5%) Information (4%) Manufacturing (11%) Finance industry (6%) Educational services (9%) Professional business services (15%) Health care and social assistance (12%) Total Construction (6%) Trade, transportation, and utilities (13%) Leisure and hospitality (9%) Other services (8%) Agriculture, natural resources, and mining (2%) 23% 23% 23% 24% 26% 30% 31% 31% 35% 36% 39% 40% 47% 78% 77% 77% 76% 74% 70% 69% 69% 65% 64% 61% 60% 53% Eligible

Percentages next to categories indicate incidence among respondents. Due to rounding, results may not equal 100%.

2 Education pays Bureau of Labor Statistics Current Population Survey, 2011, http://www.bls.gov/emp/ep_chart_001.htm.

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Furthermore, eligible and non-eligible workers in the information industry enjoy the highest combined Lifetime Income Score (84), while workers in agriculture, natural resources, and mining have among the lowest scores (54) (Figure 4). Information industry workers are disproportionately male, younger, and highly educated, and have above-average incomes and investable assets. Workers in agriculture, natural resources, and mining are also likelier to be male, but are older and less educated, and have average incomes and investable assets.

Our survey data continue to demonstrate that qualifiedplan access is a critical component in workers pursuit of retirement security. Whats more, we continue to see those who are eligible but are not currently participating as having a relatively high probability of doing so at some point in the future either by electing to contribute or through automatic enrollment, which has become a generally accepted practice. According to a recent survey by Hewitt Associates, 57% of large employers offer automatic enrollment, and an additional 13% said they were likely to do so. 3

Figure 4. Lifetime Income Scores by industry

Total Information (4%) Public administration (5%) Educational services (9%) Manufacturing (11%) Finance industry (6%) Professional business services (15%) Health care and social assistance (12%) Construction (6%) Leisure and hospitality (9%) Trade, transportation, and utilities (13%) Agriculture, natural resources, and mining (2%) Other services (8%) 39% Eligible Not eligible 84% 40% 80% 43% 43% 44% 69% 43% 42% 39% 42% 42% 55% 40% 45% 53% 54% 62% 74% 78% 67% 64% 59% 58% 81% 83% 84% 82% 86% 76% 70% 93% 91% 100% 99%

Percentages next to categories indicate incidence among respondents.

3 Hot Topics in Retirement 2011, Hewitt Associates, 2011, http://www.aon.com/attachments/thought-leadership/2011%20 Hot%20Topics_Final.pdf.

MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

The impact of home equity and business ownership As we know, money that individuals use to fund their retirement may come from a variety of sources other than retirement savings and Social Security. In fact, many people expect that their home equity and business ownership will represent key supports once they leave the workplace. Adding these two factors to retirement income, the median Lifetime Income Score for all survey respondents nationally rises from 65 to 70. While this may seem like a modest increase, the impact is more significant for those segments that currently own real estate or businesses (Figure 5). Our data show that 58% of survey respondents own real estate, but only 18% own a business. Among workers who expect to apply their real estate equity to retirement income, the base Lifetime Income Score is 77, but rises to 84 when home equity is factored in. Similarly, among workers who expect to apply business value to retirement income (11%), the base Lifetime Income Score is 70, but rises to 92 when business value is taken into account. Lastly, for those who expect to add real estate or business value, the base score is 75, but rises to 85 when either factor is taken into account.

Figure 5. Home and business ownership give a boost to median LIS

LIS LIS Plus 92% 77% Lifetime Income Score 84% 70% 75% 85%

Expect Real Estate Equity (27%)

Expect Business Value (11%)

Expect Real Estate or Business Value (33%)

Percentages next to categories indicate incidence among respondents.

PUTNAM INVESTM ENTS |putnam.com

Among workers who expect to apply real estate or business value to retirement income, the base Lifetime Income Score is 75, but rises to 85 when real estate or business value is taken into account.
Financial behavior Arguably the most important factor in the determination of retirement preparedness is financial behavior. Defined contribution (DC) plan participation, the use of an advisor, and a general propensity to save all form the bedrock of respondents Lifetime Income Scores. Compared with our initial survey, total household retirement savings inside and outside workplace retirement plans increased from 12.1% of income to 14.2% by year-end 2011. The lions share of this increase came from households eligible to participate in workplace retirement plans. These households increased their DC deferral rate from 8% to 9% on average and increased their retirement savings outside their workplace plan from 8% to 10%. Looking across deferral rates in DC plans, the greatest difference year over year occurred for those households that defer more than 10% of their income to their retirement savings. Rising from a median score of 124 to 145 in our latest survey results (Figure 6), this robust level of participation in workplace savings plans continues to be a critical factor in helping ensure retirement security.

Figure 6. Scores improved the most for households with the highest deferral rates
2012 2011 Lifetime Income Score 145% 124%

85% 54% 58% 61% 65%

84%

0% deferral rate (5%)

0.01% to < 4% deferral rate (13%)

4% to < 10% deferral rate (23%) Deferral rates

10%+ deferral rate (20%)

Percentages next to categories indicate incidence among respondents.

MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

Investors decision to use or not use a financial advisor also had a sizable impact on Lifetime Income Scores over the past year. Those who worked with a financial advisor rose from a median score of 82 to 89, while those who did not utilize such services declined from 61 to 58 (Figure 7). Figure 7. Scores improved for those who use advisors
89% 82% Lifetime Income Score 2012 2011

Figure 8. Non-advised qualified plan portfolios have the majority of their assets in cash

Cash, money market mutual funds, or other cash equivalents 37%

Stock or stock mutual funds 42%

Bonds or bond mutual funds 22% Advised

Cash, money market mutual funds, or other cash equivalents 57%

Stock or stock mutual funds 30% Bonds or bond mutual funds 14%

Not Advised

Due to rounding, results may not equal 100%.

61% 58%

Have a paid advisor (24%) Do not have a paid advisor (76%)

Percentages next to categories indicate incidence among respondents.

Generally speaking, investors moved a greater share of retirement assets into the most conservative investment vehicles over the course of 2011. Both outside and inside qualified retirement plans, asset allocation shifted sharply to cash rising from 43% to 52% within qualified plans primarily at the expense of equities. This has important implications for retirement savings, as investors who opt for the sidelines may significantly limit their ability to capture the upside potential of equity market rallies. Our latest survey shows that having a financial plan has a significant impact on results. Individuals with a formalized, written financial plan scored much higher than those who did not have such a plan. Looking at the portion of respondents who did have a plan (17%), 71% factored in health-care costs while in retirement. While this number sounds promising for the most prepared and correlates with higher scores for this group (Figure 9) it also tells us that only 12% of workers factor health-care costs into their retirement planning. As we will discuss, this low incidence of more comprehensive planning presents one of the biggest opportunities for investor education, especially as concerns over rising health-care costs appear to be widespread.

Within qualified plans, another revealing detail appears in a comparison of self-directed and professionally advised portfolios. Advised portfolios were more heavily weighted to equities and fixed income, while nonadvised portfolios had a pronounced bias toward cash (Figure 8).

A robust level of participation in workplace savings plans continues to be a critical factor in helping ensure retirement security.

PUTNAM INVESTM ENTS |putnam.com

Figure 9. Scores are higher for those who have a plan

117% 123%

58%

Eroding confidence As the risk-averse trend in asset allocation suggests, the majority of households are feeling more concerned about the economy and their investment prospects. More than 50% of survey respondents expect inflation will rise in the year ahead, and about a third of workers expect unemployment will rise in their local region. The greatest area of uncertainty, however, pertains to health care. Nearly 65% of workers expect health-care costs will rise in the next year and 18% expect these costs will rise substantially (Figure 10).

Lifetime Income Score

Do not have a nancial plan

Have a nancial plan

Have a plan that considers health care

Figure 10. Economic expectations

Much lower 1% Health-care costs that you pay 4% 31% 45% 18% Somewhat lower Same Somewhat higher Much higher

Ination 2% 6%

38%

43%

12%

The unemployment 3% rate nationally The unemployment rate 3% in your area Long-term interest rates 3% 12%

22%

41%

24%

10%

21%

45%

22%

9%

50%

30%

5%

The stock market

6%

21%

42%

28%

4%

Home values in your area

7%

19%

48%

23%

3%

Due to rounding, results may not equal 100%.

MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

With more than six workers in ten expecting that their out-of-pocket health-care costs will be higher in the year ahead, the proportion of workers focused on saving for these expenses is up sharply even as most other savings priorities are flat to declining (Figure 11). Against the backdrop of this uncertainty, we sought to determine the level of interest in planning tools that could bring clarity to workers over the question of health-care costs. Specifically, we gauged the level of workers interest in a planning tool that could help estimate these expenses and accommodate them in retirement planning. We found that a majority of workers 60% would be interested in this kind of tool, with 14% of all respondents expressing strong interest. Whats more, interest was strong regardless of income, level of investable assets, or Lifetime Income Score.

Significantly, the most prepared for retirement (with scores greater than 100) expressed the strongest level of interest in a health-care planning tool; similarly, 20% of households with the highest level of income ($175K+) would be very interested in such a tool (Figure 12). The health-care question is of particular importance for those who plan to retire prior to becoming eligible for Medicare, as the prevalence of employer-sponsored health-care coverage for retirees has declined dramatically in recent years. Among large, private-sector employers (200 or more employees), only 26% offered retiree health benefits in 2011, down from 28% in 2009 and 66% in 1988. 4

Figure 11. Saving for health-care costs gaining traction as a key objective
2012 Retirement Paying down debt Saving for unexpected expenses apart from health care A major purchase or expenditure somewhere in the future (home, car, boat, or vacation) Saving for health-care expenses A child's education Building an estate for your heirs 8% 13% 15% 19% 29% 26% 25% 24% 24% 33% 40% 46% 2011 62% 62%

4 2011 Employer Health Benefits Survey, Kaiser Family Foundation and Health Research & Educational Trust (HRET), http://ehbs.kff. org/pdf/2011/8225.pdf.

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PUTNAM INVESTM ENTS |putnam.com

Figure 12. Health-care planning tool interest by household income

Not interested Not very interested Somewhat interested Very interested

Total

17%

24%

46%

14%

< $50K

20%

25%

45%

10%

$50K to < $100K

17%

24%

47%

13%

$100K to < $175K

14%

21%

47%

19%

$175K+

16%

24%

40%

20%

Due to rounding, results may not equal 100%.

Factors for success One of the most encouraging findings in our initial survey, for which we began gathering data in 2010, was that households in the top quartile (replacing 100% or more of income) and the bottom quartile (replacing less than 45% of income) had exactly the same average income ($93,000). The difference was that one group had saved and invested, while the other had not. While our most recent data suggest a widening gap between lower- and higher-income households, we continue to see saving and related behaviors as the most influential factors on Lifetime Income Scores and retirement preparedness. In other words, financial decision making can make all the difference in retirement preparedness, and the future can still be altered by making positive adjustments to financial behavior.

Active participation in a DC plan Results show that eligibility to participate in an employer-sponsored plan has the most impact on Lifetime Income Scores; however, many households are not optimizing this opportunity. Deferral rates of 10% or more To help ensure adequate retirement security, households should actively participate in their employer-sponsored DC plans and defer at least 10% of their income. Use of an advisor Households utilizing the services of a paid financial advisor have access to more comprehensive and customized investment management. Those using an advisor achieved a median score that was nearly 54% higher, inclusive of Social Security. Confidence in decision making Households that indicated higher confidence in their financial decision making ability earned higher Lifetime Income Scores. This was true across several aspects of the financial planning process, from confidence in being able to achieve a financially secure retirement to understanding how much it would cost to maintain adequate health-care coverage. The key to confidence is education, and by equipping households with the tools to measure and improve their own retirement preparedness, they are then empowered to achieve a more financially secure retirement.

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MAY 2012| Lifetime Income Scores II: Our latest assessment of retirement preparedness in the United States

Survey methodology 3,958 working adults, age 18 to 65 Conducted online, 11/28/1112/26/11 Weighted to Census parameters for all working adults The Putnam Lifetime Income ScoreSM represents an estimate of the percentage of current income that an individual might need to replace from savings in order to fund retirement expenses. For example, consider an individual, 45 years old, with an income of $100,000 per year. A Lifetime Income Score of 65% indicates that the individual is on track to be able to generate $65,000 in retirement income (in todays dollars), i.e., 65% of current income. This income estimate is based on the individuals amount of current savings as well as future contributions to savings (as provided by participants in the survey) and includes investments in 401(k) plans, IRAs, taxable accounts, variable annuities, cash value of life insurance, and income from defined benefit pension plans. It also includes future wage growth from present age (e.g., 45) to the retirement age of 65 (1% greater than the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W)) as well an estimate for future Social Security benefits. The Lifetime Income Score estimate is derived from the present value discounting of the future cash flows associated with an individuals retirement savings and expenses. It incorporates the uncertainty around investment returns (consistent with historical return volatility) as well as the mortality uncertainty that creates a retirement horizon of indeterminate length. Specifically, the Lifetime Income Score procedure begins with the selection of a present value discount rate based on the individuals current retirement asset allocation (stocks, bonds, and cash). A rate is determined from historical returns such that 90% of the empirical observations of the returns associated with the asset allocation are greater than the selected discount rate. This rate is then used for all discounting of the survival probability-weighted cash flows to derive a present value of a retirement plan.

Alternative spending levels in retirement are examined in conjunction with this discounting process until the present value of cash flows is exactly zero. The spending level that generates a zero retirement plan present value is the income estimate selected as the basis for the Lifetime Income Score. In other words, it is an income level that is consistent with a 90% confidence in funding retirement. It is viewed as a sustainable spending level and one that is an appropriate benchmark for retirement planning. The survey is not a prediction, and results may be higher or lower based on actual market returns.

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