Mark Hulbert: Reality check: Is there truly a retirement ‘crisis’?
Is there a retirement “crisis,” or isn’t there?
Though this is hardly a new question, it has been brought to the forefront recently by a vigorous debate at the excellent Advisor Perspectives website. While most who posted comments in that debate supported the conventional wisdom that there is such a crisis, a few voiced a vigorous dissent.
Josh Scandlen, a Certified Financial Planner based in Alpharetta, Ga., was one such dissenter: “The purported ‘Retirement Crisis’ is nothing more than a way for the industry to scare people into staying working for longer and longer instead of enjoying the remaining years of their lives.”
This debate prompted me to do a deep dive into the research to see what the data show about such a crisis. While you might not care about the debate, since the only crisis you care about is your own, we still can gain insight into our personal situations by understanding the challenges that others face.
Consider first the findings of Boston College’s Center for Retirement Research. Researchers at that institution periodically calculate a “National Retirement Risk Index,” which reflects the percentage of working-age households whose standard of living is likely to significantly decline in retirement. The CRR bases its Index on data in the Federal Reserve’s triennial “Survey of Consumer Finances.”
The latest index reading is 50%. It certainly seems like a crisis when fully half of current working-age households face a significant reduction in standard of living when they eventually retire.
Similarly sober results were reached by the Employee Benefit Research Institute (EBRI). In 2003 that firm developed a “Retirement Security Projection Model,” and in the years since it has revised and improved it, taking into account “updates for financial and real-estate market performance, employee demographics, and real-world behavior of 401(k) participants (based on a database of 27 million 401(k) participants) and IRA account holders (based on a database of 20 million unique individuals).”
According to the latest update of the EBRI model, published this past March, “40.6 percent of all U.S. households where the head of the household is between 35 and 64, inclusive, are projected to run short of money in retirement.”
Given the complex econometrics involved in these projections, to say nothing of the myriad assumptions one has to make about the future returns of equities, bonds and real estate, as well as likely spending and saving patterns, the EBRI and CRR estimates seem quite similar.
Needless to say, however, not all researchers come to the same conclusion. Take a study conducted a decade ago entitled “Are All Americans Saving ‘Optimally’ for Retirement?” Its authors were two economics professors at the University of Wisconsin—Madison: John Karl Scholz and Ananth Seshadri. They focused on households whose heads were 50 years old or older at the time of their study, and found that only 4% were at risk—defined as having net worth below their “optimal targets” for retirement wealth preparation.
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How could these different studies from such reputable institutions and researchers reach such different conclusions? There is one key difference between the approaches taken by the various studies, and it’s helpful to understand it because it shows how seemingly minor changes in our behavior can have an outsize impact on our retirement standards of living.
This key difference centers on whether consumption levels naturally decline as we approach retirement and continue to decline after retirement. If they do, then the National Retirement Risk Index may be exaggerating the proportion of households that are at risk. That’s because retirees don’t need to replace as high a percentage of their preretirement income as otherwise appears to be the case when looking at their working-age salaries and net worth.
On the one hand, it certainly seems plausible that consumption levels would decline as we approach and then enter retirement. After our kids grow up and leave home, for example, our expenses can decline dramatically; we no longer are feeding them, for example, much less paying for college tuition. And, once in retirement, we may very well front-load our discretionary spending—traveling, for example—on the theory that in those earlier retirement years we can derive more benefit from that consumption.
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On the other hand, Geoffrey Sanzenbacher, associate director of research at Boston College’s Center for Retirement Research, told me in an interview that this notion is not supported by a lot of empirical evidence. Some studies have shown that household consumption does not significantly decline as kids leave home, for example. And while some other studies do show that consumption does decline during retirement, it’s difficult to know whether that’s because retirees actually want to spend less as they get older or whether they have no choice because they’re running out of money.
No doubt researchers will continue to study this question. The takeaway for you individually, however, has to do with how you go about calculating what you need to save for retirement.
Many financial planners, for example, tell clients that they need to replace between 70% and 85% of their preretirement income. If you’re 50 years old with kids at home or in college, for example, the application of that formula might lead you to think you need more for retirement than is actually necessary. What you should instead do is project how much you are likely to be spending in your final preretirement year, and then multiply that number by 70% to 85%.
At the same time, however, you need to be brutally honest with yourself about your spending and saving patterns after your kids leave home and/or college. Would you actually reduce the amount of money you’d spend? Or would you go on a shopping spree, undertaking that home renovation and embarking on that dream round-the-world vacation? Or would you actually save and invest that money?
Be honest with yourself as you ponder those questions. You don’t want to make the mistake of thinking that “of course” you’d cut back your spending when in fact you would not. If you make that mistake, you’ll only discover when it’s too late that your retirement standard of living must fall significantly.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org.