At MarketWatch on Thursday (requires free registration), Paul Farrell did his roughly annual “you’re being lied to by financial planners about retirement” schtick:
….. Warning, you’re being hypnotized: Wall Street insiders, bankers, brokers, advisers and their buddies want you to pile up assets. Why? Not for your own good, but because the more securities you own, the more money they make in fees! Get it?
….. In other words, Wall Street and friends have a substantial unstated self-interest in encouraging you to invest more than you need for retirement. I’ve been making this argument for years and finally it’s being documented in research by economists who also aren’t buying into Wall Street’s hype.
The leader of this counterintuitive challenge is Larry Kotlikoff, a Boston University economics professor and co-author of “The Coming Generational Storm,” an analysis of dire solutions necessary to cover future unfunded Social Security and Medicare benefits. His co-author is financial columnist Scott Burns of the Dallas Morning News. Kotlikoff’s research says investors should focus on income while working to figure out retirement needs.Saving too much? You bet. A New York Times review of Kotlikoff’s numbers “showed that Fidelity’s online calculators typically set the target of assets needed to cover spending in retirement 36.4% too high. Vanguard’s was 53.1% too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78%” higher than the calculations generated by Kotlikoff’s ESPlanner.
Well, I have a “self-interest” in this too, because I do workshops designed to help people think this issue through, and build customized models for each individual company’s class for that purpose. But do I think I’m misleading people into saving too much? Nope.
Cutting to the chase — Most retirement calculators, and my retirement class, make an assumption about your “required income replacement percentage” during retirement, meaning the percentage of income you will need in your first year of retirement compared to your final year of work to be able to maintain your standard of living (after that, the models usually assume that a retiree’s needs will go up with inflation). The calculators tend to allow you to assume an income replacement percentage requirement of 60%-90%; my class assumes 80%.
Farrell, though he doesn’t hang a number on it, makes the perfectly valid point that many retirees are indeed able to get by on relatively little, because for them all of the often-substantial expenses involved in raising kids have gone away, and haven’t been replaced by other expenses.
But that’s today. What about the future? I believe that you can consider Farrell to be generally right about his complaint only if ALL of the following things are true:
- There is no chance Social Security benefits will be reduced below where they are now in real terms (the typical retirement model assumes that Social Security will stay as is).
- There is no chance that Medicare premiums or post-retirement health care costs will will become much more significant out-of-pocket costs for retirees than they are today.
- The typical retiree will go into retirement relatively debt-free.
All those who believe those three statements are true, raise their hands. (I’m not seeing any; I never do.) The younger you are, the more likely it is that you will be whipsawed by one or more of these three factors, especially Social Security and/or Medicare.
Now here is a rough cut at the potential impact of those items:
- If Social Security benefits have to be cut substantially (and at the rate we’re going, which is nowhere in a hurry, either there will be big benefit cuts or huge increases in other taxes, and they could even start kicking in within 10 years), a typical retiree could very well be required to come up with about 10% or so of his/her/their total needs from somewhere else — i.e., savings, if it’s there.
- If post-retirement health care costs go up by a lot, it would not be at all surprising to see the required income replacement percentage jump by 8%-10% — which of course will have to come from savings, if it’s there.
- Farrell is clearly assuming that the typical retiree is debt-free. For discussion purposes, let’s assume that a debt-free retiree who made $60,000 ($5,000 a month) in the final year of work only needs 50% income replacement for “living expenses,” or $30,000 ($2,500 a month, to get by during retirement at a comparable standard of living:
– Ah, but what if that person has a $400 monthly car payment? Add 8%, and hope the car goes a long time without needing to be replaced after it has been paid off.
– What if that person is also 15 or more years away from paying off their house, which has a $750 payment? Add another 15%.
– What if the person still has about $10,000 in credit card debt, against which a reasonable person would try to pay at least $500 every month (there is not a shortage of seniors who come into retirement in that condition)? Add 10% more, at least for the first few years.
– You can see that I’ve easily pushed this retiree’s income replacement percentage requirement above 80% for at least the first few years of retirement — and I haven’t even factored in any possible changes for the worse in Social Security or Medicare.
– Any or all of these items, if present, will have to be covered by (you guessed it) savings — if it’s there.
So what are some of the “bad things” that could happen to people who save too much for retirement? Here are just a few:
- They could get laid off a few years before they planned to retire, and essentially be forced to retire early, or to find a job that won’t pay them anywhere near what they were earning before. It’s not like this doesn’t happen — a lot. It would be sort of nice to have what you thought was “too much” money in the 401(k) at that point, doncha think?
- They may have the flexibility to quit work or go part-time to assist in the care of an aging parent or relative should that become necessary.
- They could end up with a bunch of extra money that they will conclude they can give to charity, family, or friends. Nice problem.
- They’ll be less likely to be compelled to sell their house or to seriously downsize living arrangements during retirement, because the chances of the money not lasting as long as expected will be pretty low.
I would suggest that these and other similar items are “bad things” most people would enjoy having the financial ability or flexibility to deal with. And, I should add, nobody would suggest that you live like a miser during your entire working career in hopes of “guaranteeing” a comfortable retirement.
In fairness, Farrell makes a lot of good planning and other suggestions for making sure that post-retirement expenses are as low as possible. But neither he, nor you, nor I can individually control what the politicians are going to do to Social Security and/or Medicare, and the current crew in Washington (legislative and executive) doesn’t inspire a lot of confidence.
Farrell’s point about the financial services industry’s self-interest is also spot-on. So is there a way to save a lot for retirement without lining the industry’s pockets excessively? Sure — and that’s a subject for tomorrow.