Is the industry unnecessarily scaring retirement savers into believing they face a retirement crisis?
In the press release accompanying the publication of The Essential Retirement Guide: A Contrarian’s Perspective, author Frederick Vettesse levels a stinging criticism against the financial services industry.
As chief actuary at Morneau Shepell, a Toronto-based benefits consultancy with a U.S. footprint in Atlanta, Vettesse has spent the past four decades consulting sponsors of public and private pension and defined contributions plans.
These days he spends most of his time writing about what he has learned helping institutions craft retirement strategy and policy.
What he has to say about retirement income replacement rates recommended by asset managers and plan advisors is as the title of his book suggests — contrarian.
The 70 to 80 percent replacement rate rule of thumb is unrealistically high, says Vettesse, and “clearly wrong for the majority of savers.”
His thesis doesn’t stop there. In the press release, Vettesse is quoted as saying: “One is tempted to wonder whether the overstatement stems from the fact that the financial services industry makes more money when people save more.”
In an interview, Vettesse walked back that insinuation, but vigorously defended his book’s core proposition: that industry is advancing unnecessarily high and mostly unachievable savings recommendations, with the end result of scaring investors into believing they face an impending retirement savings crisis.
“It is ridiculous that we are still having this debate,” Vettesse told our sister site, BenefitsPro. “These questions should have been put to bed 20 years ago.”
Exaggerated replacement rates fail to accurately account for how much — or how little — income is spent on personal consumption during working years, says Vettesse.
Personal consumption is that component of living costs that is separate from taxes, mortgage payments, the cost of raising kids, and income deferred to saving.
According to the numbers in his book, personal consumption as a percentage of gross income peaks for couples in the 10 years prior to retirement, at 45 percent.
He advocates keeping personal consumption rates in retirement equal to pre-retirement age.
The lower income replacement rates he recommends presume that by retirement, mortgages are largely paid off, kids have left the nest, taxable income will be lower, as will the expense of saving, as retirees enter the decumulation phase of life.
His book sets more modest replacement income rates, which vary on income levels, marital status, whether or not couples raised children, and whether or not savers were homeowners.
According to his math, only the minority will have to save aggressively enough to replace 70 percent of their income in retirement: Middle income to upper income workers with no kids that rent will need to replace 70 percent of income to retire comfortably.
But most of the cohorts examined in Vettesse’s book will not need to save nearly as aggressively.
For instance, a couple making a combined $96,000 who raised two or more children and owned a home will only need to replace 47 percent of that income to retire comfortably.
Upper-middle income couples earning $160,000 with two or more kids and owning a home will need to replace 44 percent of income, and the wealthiest couples with $250,000 or more in income will only need to replace 40 percent of income.
Vettesse’s recommended replacement rates go up as the number of children go down, and are the most for non-homeowners, who will have to continue to pay rent in retirement.
He proposes a new rule of thumb replacement rate for three increments of savers:
50 percent for couples who raised at least one child and paid a mortgage
60 percent for savers who either raised children or paid a mortgage, but not both
70 percent for savers who rented their entire working lives and did not have kids
“The bottom line is that setting a 70 percent replacement rate as a rule of thumb for everyone makes no sense—this should be obvious to anybody,” said Vettesse.
He says the 70 percent rule of thumb was derived from the replacement rates aimed for in traditional defined benefit plans, which Vettesse argues are “too rich.”
Over the past decades, industry and plan consultants have piggybacked off replacement rate benchmarks for defined benefit plans as employers made the transition to defined contribution plans, explained Vettesse, who described himself as a conservative.
And though he stopped short of claiming an “outright conspiracy” among retirement product and plan providers, he did say, “if a lower replacement rate were in their best interest, I suspect they would have been advancing one some time ago.”
Vettesse is critical of recent research from Fidelity that advocates cumulative retirement savings, outside of Social Security, should be 10 times a retiree’s highest salary.
In its biennial Retirement Savings Assessment study, Fidelity research shows that 55 percent of American households are at risk of not being able to cover basic expenses in retirement.
Baby boomers are in the best shape, given their higher earnings and longer savings history, but even their median annual savings rate — 9.7 percent of salary — is far below Fidelity’s recommended annual savings rate of 15 percent.
That number — 15 percent — troubles Vettesse.
He’s not alone. Andrew Biggs, a resident economist at the American Enterprise Institute, a Washington D.C.-based conservative think thank, has also questioned Fidelity’s research.
In recent columns published in the Wall Street Journal and Forbes, Biggs took aim at the 70 percent replacement rate rule of thumb, and even challenged the idea that the nation is facing a retirement savings crisis.
“Where exactly did the 70 percent target replacement rate come from — we’re not really sure,” Biggs told BenefitsPro. “It’s a soft number.”
Neither Biggs nor Vettesse were familiar with the others’ work.
According to Biggs, industry retirement income benchmarks have traditionally been higher than academics’. He differs from Vettesse in that he doesn’t think industry’s profit motives are the reason behind the recommended replacement rates he says are high.
“I’m not accusing industry of being disingenuous,” said Biggs. “I just think they are wrong.”
Biggs says he isn’t necessarily arguing that the 70 percent income replacement rate be scrapped, but he does say that benchmark warrants further study.
He uses earnings and Social Security benefit data from the Social Security Administration to show that an average wage worker would retire with a 107 percent replacement rate if they were to follow Fidelity’s recommendation—to save 15 percent annually so that aggregate savings would be 10 times one’s final salary.
From his perspective, Fidelity’s recommendations are unnecessarily high, and result in a savings rate that is difficult for many workers to meet.
That ultimately perpetuates the larger idea that country is indeed suffering a retirement crisis, which Biggs says gives fodder to the argument that Social Security benefits should be expanded, to help cover for the savings shortfall.
That’s troublesome to Biggs, particularly in an election year, and as Social Security’s projected shortfalls have climbed by trillions over the past decade.
“Promising more than we can deliver is human nature,” said Biggs. “And in a campaign season, everyone wants new promises.”
A sliding scale for replacement rates
Jeanne Thompson, vice president for thought leadership at Fidelity, was one of the firm’s leaders behind the new retirement readiness data.
She says Fidelity’s approach to establishing savings rates has grown with the market.
The recommended aggregated savings of 10-times final salary is actually an increase from several years ago, when Fidelity was recommending plan participants save eight times their final salary.
“We found that employers liked having a round, simple way of gauging savings success for participants,” said Thompson. “It motivated sponsors’ thinking and gave them a way to engage participants in the savings conversation.”
Those conversations encouraged more questions from sponsors and participants, and motivated Fidelity to improve its research to create enhanced guidelines.
“We’ve moved to more of a sliding scale — there is no ‘one-size-fits-all’ savings rate,” said Thompson.
Higher earners will have less of their income replaced by Social Security, of course. The wealthiest will also not have to replace as much of their income in retirement to make ends meet, she said.
From the retirement consumption data gleaned by Fidelity, the firm sets savings rates so that assets in workplace retirement plans account for 45 percent of retirement income. Social Security covers the rest.
“Our job is to lay out a path that has the best chance for success,” explained Thompson. “We don’t want to put out guidelines that are right 50 percent of the time. Any good assumption has to attempt to account for the unknowns.”
Those unknowns are numerous, says Thompson. Increasing longevity estimates and out-of-pocket health care costs are among the largest wildcards. Then there is the cost of long-term care at the end of retirement, a figure even the most sophisticated of health care cost models fail to account for, says Thompson.
In order to assure a higher level of success for savers, Fidelity builds conservative assumptions into its modeling.
A longer than average life is assumed — 92. And so are conservative market returns; Fidelity assumes a 3 percent annual rate of return on investments to account for potential market downturns.
“The goal with savings rates is to engage people, not provide across the board absolutes for everyone,” said Thompson.
“Everyone’s situation is unique,” she added. “That’s why individual guidance is so important for savers.”
Editor's note: This is part 1 of a series; part 2 coming soon offers views from the retirement industry.
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