“Conventional financial planning uses a rule of thumb, or what I call a rule of dumb,” says Laurence Kotlikoff, a professor of economics at Boston University and president of Boston-based Economic Security Planning. “That rule says individuals should have enough in savings and life insurance to replace 75% or 80% of their pre-retirement earnings during their retirement years. These replacement rates are way too high for most households.”
Kotlikoff is not alone in this assessment. And, joining other economists in recent months, he questions the widely held belief that Americans, boomers among them, need to be saving more for retirement. Emblematic of this view is an October 2006 study, “Is There a Savings Crisis: Measuring the Adequacy of Household Retirement Wealth,” which concluded that the wave of boomers now pushing 60 are “accumulating adequate retirement wealth.”
Similarly, another study, “Are Americans Saving Optimally for Retirement?” found that more than 80% of individuals born between 1931 and 1941 saved enough to maintain their pre-retirement standard of living. The report did not look at boomers, but co-author John Karl Scholz, an economics professor at the University of Wisconsin at Madison, says he has no reason to believe the generation now entering retirement is financially worse off.
“If you compare the amount of net worth accumulated by households in the boomer generation to older generations at a given age, you’ll see that boomers are right on track,” says Scholz. “That leads me to think that our conclusions for the generation born between 1931 and 1941 hold for boomers.”
One target of the economists’ criticisms are popular online retirement calculators, which, they say, are at best crude tools for estimating savings and life insurance requirements. Kotlikoff’s own research highlights another problem: the calculators’ reliance–and, he contends, the financial planning profession’s reliance–on retirement and survivor spending targets.
These targets, says Kotlikoff, erroneously assume that households make no changes to spending, irrespective of federal and state tax rates, portfolio performance or other factors that might impact clients’ financial health. Consumption smoothing, an economics concept which postulates that individuals adjust savings, insurance coverage and investments to mitigate fluctuations in living standards, is at cross-purposes with such targeted spending, he observes.
When planners use clients’ current spending levels to estimate post-retirement needs, they are likely to err by recommending insurance coverage and savings rates that are higher or lower than what the client can sustain. If, for example, the planner sets the spending target too high, the household will have a standard of living that is lower than necessary prior to retirement and one that is unnecessarily high after retirement. The reverse, says Kotlikoff, will hold true if the spending target is too low.
In a 2006 report “Is Conventional Financial Planning Good for Your Financial Health,” Kotlikoff asserts that a targeted spending level that misses the mark by 10% will result in a post-retirement living standard that is 30% too high or too low. The 4 online calculators that Kotlikoff reviewed in the report–Fidelity, America Funds, Vanguard and TIAA-CREF–overestimated savings and post-retirement spending rates from 36% to 78%.
“Even if you’re off by 10% in your target, you’re making a 10% mistake for 40 years between ages 60 and 100,” says Kotlikoff. “The methodology is medieval.”
But advisors contacted by National Underwriter say such spending targets establish useful benchmarks with which to build planning recommendations. And they emphasize the targets are but one among many variables they consider in fact-finding interviews.
They also question whether over-estimating retirement spending is really an issue. Expenditures often rise, they note, particularly in the years immediately following retirement, as individuals pursue leisure activities unavailable to them during their working years.
“I’m not seeing many people who retire early go to a reduced standard of living,” says Todd Bramson, a financial planner and principal of North Star Resource Group, Madison, Wis. “They tend to be at the same or an even greater level if they’re mobile. They travel more and spend more.”
Jim Johnson, a financial planner and principal at Lighthouse Financial Planning, Sacramento, Calif., agrees, adding: “In my experience, if people have enough money, they’ll continue to spend in retirement what they did when they were working. Only the categories change. Work-related outlays go away and travel expenses go up.”
For most clients, sources say, the increase in leisure pursuits continues until the late retirement years, when they reduce these activities because of a decline in health or energy. In tandem with the slowdown comes a rise–often quite substantial–in uninsured medical and related costs.
Ultimately, planners say, the client’s financial goals for retirement, the distance between current means and objectives, and the client’s ability and willingness to do what’s necessary today to attain these aims will guide the financial planning process. Economic concepts and numerical benchmarks have their place, but developing a custom-fit solution requires of the advisor a detailed exploration of the individual’s values and unique financial situation.
“Our job as financial advisors is to help our clients deal with their priorities and make sure that dollars are available to put away for retirement without deteriorating their standard of living today,” says Herbert Daroff, a partner at BayState Financial Services, Boston. “From there, we can build a proper distribution strategy so they can enjoy a fulfilling lifestyle in their golden years.”