Low interest rates driving estimated cost of retirement income skyward

The cost of funding a retirement income has leaped over the past year for employees about 10 years away from retirement, if calculations embedded in asset manager BlackRock’s Cost of Retirement Income Index are accurate.

As a result, those workers closing in on traditional retirement age may have to recompute the amount of money they’ll need to live comfortably, and significantly up their contributions to any workplace-sponsored retirement plan during their final working years.

Specifically, BlackRock’s CoRI Index leaped by 33% at the end of 2014, a prediction that may confound 55-year-olds whose retirement assets grew significantly in last year’s equity bull market.

The reason the CoRI index went up so dramatically, the company notes: “The continued slump in interest rates where yields on 10-year U.S. Treasury notes fell a staggering 28.62% last year,” according to BlackRock’s summary of the results.

Moreover, BlackRock’s analysts are predicting that while interest rates might inch up a bit in 2015, they will “be low for some time to come.”

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BlackRock’s CoRI Index value for 55-year-olds is now $16.62, up from $12.47. Those numbers allow retirement income projections as follows: The number of dollars (in thousands) that an employee wants to have in retirement income at age is multiplied by that index value.

Thus a 55-year-old who is shooting for a $45,000 retirement income beginning 10 years from now would need 45 times $16.62, or $747,900 already saved up, to pull it off.

Unfortunately, the median retirement portfolio of 55-year-olds today is $280,035, which would fund an estimated $16,849 annual annuity at 65 – not much to live on, when inflation is factored in. Particularly in 10 years when, even if current low rates are sustained, $16,849 will buy considerably less than today.

By BlackRock’s prediction a year ago, a 55-year-old then would “only” have needed to have amassed a $561,150 at that time … a figure that’s 33% less.

For simplicity of calculation, the index does not factor in additional retirement savings contributions that the 55-year-old would likely make; rather, it assumes that no additional annual contributions would be made. Therefore the picture might not be quite as bleak as the index suggests.

Index formula

The index is derived from multiple data points and is based primarily on U.S. and investment grade bonds – securities that annuity providers use to build their rate structures. Factors used to build the index include current interest rates, annuity prices, inflation expectations, and life expectancy.

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The purpose of the CoRI Index is to offer a future glimps, which BlackRock issues only with a barrage of disclaimers making it clear that it’s only an estimate.

Given that it is based largely on bond yields and the annuity market, the index might present a more pessimistic outlook than would be appropriate for employees who don’t plan to annuitize their entire retirement savings, and instead maintain balanced portfolios well into retirement and withdraw at a conservative rate.

Still, BlackRock’s conclusion is that the latest numbers “have a sobering message” for workers, namely that they “need to increase their savings to generate the same retirement income that a smaller nest egg a year ago was positioned to provide in retirement.”

As of Jan. 27, the CoRI indices had the following values for employees at the following sampling of stated ages:  Age 56, $17.84; age 59, $19.48; age 63, $21.91; age 65, $21.67.