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The Retirement Savings Heretics

How Much Money Will I Need in Retirement? What's the number? Ask any financial advisor and he will offer you this rule of thumb: To live in retirement at your current standard of living, you will need about 75 percent of your pre-retirement income. And here are some other accepted industry maxims you might hear: You better not spend any more than 4 percent of your nest egg a year, and keep at least

How Much Money Will I Need in Retirement?

What's the number? Ask any financial advisor and he will offer you this rule of thumb: To live in retirement at your current standard of living, you will need about 75 percent of your pre-retirement income. And here are some other accepted industry maxims you might hear: You better not spend any more than 4 percent of your nest egg a year, and keep at least 30 to 50 percent in equities (even during your golden years) to stave off the evil scourge of inflation.

But do these industry mantras make sense? Not everybody thinks so. “The rules of thumb are the rules of dumb,” scoffs Laurence Kotlikoff, a Boston University economics professor. “If you try to save that much, you will have to do without for most of your life only so you can splurge when you are 80.” Or, perhaps worse: You'll die a miser prematurely, and your family will be left to live like kings. Of course, there are many households that are saving too little, but Kotlikoff reckons that there are millions or more that are saving too much. Put another way, too many households are “under consuming” during their working years to sock away money for a retirement that may be more lavish than they need or want. Further, to meet those lofty goals, some investors are investing too aggressively.

Kotlikoff is one of the leading members of what could be termed a school of retirement heretics who question much of the conventional retirement financial-wisdom, and even received truths about the retirement period itself. Says Kotlikoff, “The industry is trying to make sales, not help people. And the advice the industry is generating is very crude.” And some of the advice — because the assumptions behind that advice and the Monte Carlo simulators are so primitive — is just plain bad, and verges on malpractice, he says.

He also has harsh criticism for many of the free retirement and insurance calculators available on the web, which, he argues, recommend five times too much saving as well as five times too much life insurance. In fact, in a research report titled, “Is Convential Financial Planning Good For Your Financial Health?” Kotlikoff analyzed four specific web calculators (Fidelity, American Funds, Vanguard, which uses Financial Engines, and TIAA-CREF). He says, “Their advice is remarkably simple, geared as it is to speed households through the planning process in a matter of minutes and quickly reach the purchase page. But quick and simple doesn't necessarily spell helpful.” The advice offered via the website “leads to dramatic over-saving thanks to retirement-spending-targeting mistakes ranging from 36 percent too high to 78 percent too high,” Kotlikoff wrote in the report. (Kotlikoff's book with syndicated columnist Scott Burns, titled Spend Till The End: The Revolutionary Guide To Raising Your Living Standard, will be out next Spring.)

Consumption Smoothing

These may seem like bold claims, but there is some math behind it. Kotlikoff says he has developed software called the Economic Security Planner ( that will help investors and their advisors “smooth out” their consumption over the course of their lives to account for their actual living needs. (Ah yes, Kotlikoff stands to make money if you buy into his version of retirement reality.)

The problem with conventional financial planning, Kotlikoff says, is that retirement savings is put on “autopilot,” where savers put in the same amount all the time. In reality, people need to save different amounts depending on what's going on in their lives, Kotlikoff says. ES Planner, a sophisticated calculator with patent-pending software, recommends a savings rate by calculating your highest sustainable living standard, and the subsequent savings and life insurance needed to maintain that living standard. “Some years it's positive, some it's negative,” he says.

“Certainly in retirement it's going to be negative — you're drawing down your assets. So saving is typically going to move all over the place when you're young and middle aged; it won't be smooth. You don't want to be putting your savings on autopilot, because if you put your saving on autopilot it means that your consumption is going to be disrupted.” Saving to buy a house may negatively impact retirement savings, as does paying for a child's college tuition or wedding. There are also an incalculable number of life “events” that must be realistically factored into the planning process.

This consumption smoothing is different from conventional financial planning in that current financial plans usually start with “forcing households to set retirement-spending and survivor-spending targets,” says Kotlikoff. That can cause errors. “Even small targeting mistakes, on the order of 10 percent, can lead to enormous mistakes in recommended saving and insurance levels, and to major disruptions, on the order of 30 percent, in living standards in retirement, or widow/widower-hood,” he says. Consumption smoothing doesn't make that mistake.

This concept was first laid out by Irving Fisher, the Yale economist, in his book The Theory of Interest. He says Fisher's ideas are what economists who work on retirement savings have in mind, but the same cannot be said for the financial services industry. “Conventional financial planning is coming up with the opposite of what's being recommended by economists. It's the opposite of consumption smoothing — it's just disrupting somebody's consumption every year in order to keep their savings unchanging, or growing at some fixed rate. What you want is for their living standard per person to be fixed, and then to adjust their spending and saving based on who is in the household. So conventional practice has it exactly backwards.”

A questioning of the standard retirement rules of thumb is gaining wider traction among advisors. “I don't use targets when preparing for retirement; any one formula is dangerous,” says Robert Haley, a CFP at Advanced Wealth Management in Portland, Ore., affiliated with Commonwealth Financial Network. Similarly Haley is skeptical of new Wall Street wealth products: “I don't think the fundamentals change from decade to decade,” he says.

Another rule of thumb that is being challenged is the 4-percent rule. This is the amount the industry says is safe to take out of your portfolio each year once you have retired; this will increase the likelihood that you won't outlive your money. However it also increases the likelihood of a miserly and meager existence in the first few years of retirement, particularly for those starting with a small lump sum. Who it unquestionably benefits is the asset manager, according to one industry source who prefers to remain anonymous. “The manager gets to hold on to your money for longer and longer,” he says. “Sometimes they like to forget that it's your money, and that they are going to have to give it back.”

Retiring Habits

Perhaps the biggest question regarding the whole retirement-planning industry is what will happen to the boomers once they actually retire? Will they blow through their lump sum? How will they spend? Will they under-consume, obsessively clipping coupons until they die? Or will they get it just right, prudently spending what they have so that they die with just enough left to cover their funerals (or leave a bequest)? The fact is, no one knows for sure how the boomers will actually behave in their golden years.

“There is no really comprehensive data on what [defined-contribution] retirees are spending in retirement, so it's hard to say what will happen with certainty,” says a spokesman for EBRI, the non-partisan Employee Benefit Research Institute based in Washington.

“I haven't seen many — or really any — definitive studies on this,” says Nicole Maestas, a researcher at Rand Corp., the Santa Monica, Calif., based think tank. (The Center for Retirement Research declined to comment.)

Some retirement specialists say that new retirees tend to spend more during the first year or two before settling down. Sun Life Financial, the insurance company, calls the phenomenon the “Saturday Syndrome,” and notes in a recent survey that most retired people say that income needs vary from year to year.

Sun Life also found that in the first five years, most retirees want to have fun. “There is a big buildup to retirement,” says Christopher Kiley, a CFP with Retirement Capital Advisors, an RIA in Cincinnati, affiliated with broker/dealer Triad Advisors. “They've delayed gratification all these years. Some take the trip of a lifetime, do stuff to help the kids and do all those things they put off.” Kiley says that in his experience 4 percent is on the low side; in some cases, he has clients who spend an average of 6 to 8 percent.

One thing we do know is that retirees are happy — happier than before they retired. And money may have nothing to do with it. According to a Carnegie Mellon survey, people experience much fewer financial woes in retirement than they anticipated. What is important to people in retirement changes from pre-retirement. Quality of leisure time stands out as paramount, rising to the equivalent level of the job for the “pre-retired,” according to economist George Loewenstein's survey, “Psychological Perspectives on the Economic Aspects of Retirement.”

Loewenstein's findings about the psychological importance of income in retirement are remarkable: “The most significant difference between the two groups [the retired and non-retired] is their responses to the statement, ‘I should have calculated how much money I would need to save in order to have an adequate retirement income.’ It is startling that the non-retired endorse this statement, but the retired do not. Apparently the non-retired fear they will have too little wealth when they retire, but the retired find they can manage.”

Loewenstein concludes, “Although income maintenance is important, it is only one of many policies — and possibly not the most important or effective one — that could augment the well being of retirees.” These findings need to be reproduced in more robust studies. But if true, they are completely at odds with the urgent save-more message of the retirement-planning industry, however much lip service it may pay to the non-financial joys of retirement.

As advisors start to help clients make the shift from pre-retirement to retirement, they need to at least consider some of the insights from the retirement heretics, even if they don't agree with them, as well as what we know — or really don't know — about life in retirement. Every case is different, says Kiley, the Cincinnati-based CFP. “There is no one set formula” for everyone, he says. And, sure, he's had to give prospective clients who came to visit for retirement reasons some bad news. Kiley thinks, “The media is driving people to think about saving for retirement. Some of it may seem like scare tactics to save as much as you can, but I don't really have a problem with it. Because in reality, people don't save what they should.”


Most financial plans assume some contribution from Social Security and Medicare. Trouble is, those entitlement programs are expected to go broke, and the way they are “fixed” may adversely affect your clients' retirements. by Jagadeesh Gokhale

Social Security projections show revenue shortfalls emerging as early as 2017, and, worse, the Social Security trust fund could run out by the early 2040s — well within many baby boomers' lifetimes. Medicare is in even worse shape. Its trust fund is projected to be exhausted by 2019 (and that's under relatively benign health-care-cost growth assumptions). Under midrange economic and population projections, official estimates of the two programs' shortfalls over the next 75 years total $41 trillion — or three-quarters of total U.S. household wealth.

Fewer Benefits, Higher Taxes?

With such large financial imbalances, Social Security and Medicare are both likely to be reformed, but it's hard to say when and how. Based on past reforms and proposals being floated, it seems boomers will shoulder at least part of the burden. Reforms may curb entitlement expenditures by postponing benefit-eligibility ages or levying higher income taxes on the benefits of retirees with substantial other income sources. If payroll taxes are raised in the next decade, younger boomers would have smaller disposable incomes from which to save for retirement.

Of course, boomers have significant political clout, and may succeed in preventing future entitlement reforms from directly affecting their own retirement benefits. But the consequence would be much larger tax burdens or benefit cuts for succeeding generations. Some analysts envision a “generational war” over entitlement reforms. Quite likely, such a war will be covert: Younger workers, facing massive tax increases, would choose to acquire less education and fewer skills, work less or emigrate. If that happens, retired boomers would again experience living-standard declines — indirectly through slower productivity and economic growth, a key source for sustaining retiree benefit levels and healthcare quality.

Finally, how will looming entitlement shortfalls affect capital markets? Those markets are global, but so are shortfalls in public pension and health care programs. Compared to the United States, most major European economies, Japan and even fast-growing China are undergoing even more rapid population aging. All have massive baby boomer cohorts entering retirement, and all face similar political hurdles in enacting fiscal reforms. If entitlement reforms are continually postponed, national debts will increase. Eventually, public confidence in governments' abilities to pay those debts will cause higher-interest rates, rising prices and higher-inflation expectations — all inimical to future economic growth. Of course, the timing of such developments is difficult to predict.

This inscrutable brown cloud in our entitlement-reform crystal ball implies at least two things: First, massive entitlement shortfalls mean that most estimates of the number of boomer households facing financial jeopardy in retirement is surely understated. Second, many financial planners suggest maintaining a reserve fund, a sort of personal insurance against adverse market developments. But the policy uncertainty associated with entitlements changes the risk attached to saving more: Saving less is risky because the government may default on its entitlement-benefit promises. But saving more may be pointless if the government would only impose heavier taxes on future asset incomes or consumption.

What's called for under the circumstances involves more than just increased savings. The familiar dictum of Risk Management 101: “When uncertainty increases, diversify more” needs to be adopted. But in broader terms, those boomers whose retirements may be in jeopardy are going to have to save a little more, work a little longer, diversify asset portfolios, take greater advantage of tax breaks available today, and last but not least, become politically active. Boomers should push to resolve entitlement shortfalls earlier, and reduce the scope for governments to fool the public by promising unpayable benefits and mismanaging an essentially private function: saving and disposing of our retirement wealth according to our preferences rather than those of politicians and government bureaucrats.

The author is a senior fellow at the Cato Institute.


Baby boomers have begun inheriting their parents' estates. Some hope that will put them in the black, what with government entitlements likely to be cut. Alas, only 2 percent of baby boomers will receive an inheritance of more than $100,000.

Source: Federal Reserve and Tiburon Research & Analysis

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