Socking Too Much Away
Forget the common assumption. Some people may be saving more than they will need for their golden years
Over the years, financial adviser Richard Ferri has seen a few clients go to that great retirement community in the sky. And they have all left behind something: money. Lots of it. "We've never had a client die with less money than they retired with," says Ferri, who works in Troy, Mich. "If they retire with $2 million, they end up with $4 million. The value of the account goes up more than they anticipated, and they don't spend as much as they thought they were going to spend."
In fact, Ferri suspects a lot of wealthy Americans actually oversave for retirement and "become overly concerned with putting money away." In an era of high anxiety about retirement finances, the idea that some workers are socking away more than they need is counterintuitive. But a widely debated study suggests Ferri may be right.
In a report published in the Journal of Financial Planning last year, Eau Claire, Wis., financial planner Ty Bernicke examined federal statistics and discovered an assumption-bursting fact: Seniors actually go through less money as they get older. By contrast, many financial advisers figure that retirees will spend at the same rate until they die, and they rely on this conventional wisdom in crunching numbers.
Nonsavers. How many people are oversaving for retirement? Experts agree that it's probably a fairly small number. After all, American saving rates are low, and many young people aren't taking full advantage of 401(k)'s at the workplace. Indeed, fewer than a third of current workers say they and their spouses have saved more than $50,000 for retirement, according to a new survey by the Employee Benefit Research Institute.
Still, Bernicke's study suggests that retirement savings may last longer than many people think. According to Bernicke, a typical household whose residents are over 75 spent $25,763 in 2004. Back in 1984, that same household would have spent $43,000 in inflation-adjusted dollars. Seniors "tend to be more active in their early years and less active in their later years," Bernicke says. "Their spending goes down." Yes, retirees often blow out their savings on expensive vacations and hobbies shortly after they stop working. And they often spoil their grandchildren and bail out their own kids when they need help. But then they start to slow down, Bernicke says, and stop driving and traveling as much. As a result, older retirees need less money to get by.
Bernicke says that the grow-old-and-spend-less principle applies to retirees across the board, suggesting that baby boomers won't be exempt. "Every generation decreases spending dramatically as age increases throughout retirement," Bernicke writes. Could this be because seniors simply run out of money to spend? Not so, reported Bernicke, who found that the average net worth of American seniors actually grows as they get older.
Taking Bernicke's theory into account can make a big difference in retirement planning. Under one traditional prediction model, a couple who spend $60,000 a year and have $800,000 in 401(k) savings at age 55 would have only a 13 percent chance of having enough money to make it to age 85, assuming that their spending habits remained constant. But the chances of success--making it to age 85 with enough money--jump to an impressive 100 percent when the model assumes that the couple will spend less over time.
What about medical costs, which are rising faster than inflation? Bernicke doesn't think health expenses will grow enough to make up for lower spending on things like travel, entertainment, clothing, and transportation. As people progress through retirement, "health costs are going up but at a slower pace than everything else is going down," he says.
Sitting at home. Bernicke's spending theory makes sense to Robert Brokamp, editor of Motley Fool's Rule Your Retirement newsletter. "The average 75-year-old doesn't require as much stimulation and entertainment. You get to a point where you don't feel like going out that much; you're happy sitting at home and reading books." Medical problems are clearly a factor in keeping older seniors in their easy chairs: A 2000-2002 federal survey found that the percentage of Americans who rate their health as only "fair" or "poor" jumps from 23 percent in the 65-to-74 age group to 35 percent among those 85 and older.
But Brokamp still doesn't like the message that Bernicke's research sends. The risk, he says, is that it will give people an excuse to save less. "The statistics show overwhelmingly that the average person doesn't have enough for retirement. The last thing most people need is something to [make them think], 'I don't really need to save that much.'"
How can you make sure the amount of money you're saving for retirement is a Goldilocksian "just right"? It's an especially dicey question when workers have more control over retirement savings than ever before because of the demise of automatic, no-hassle pensions.
The numbers tell the story: The portion of American families with only a defined pension plan declined from 40 percent in 1992 to 24 percent in 2004, according to a report released this month by the Employee Benefit Research Institute. But the percentage of families with 401(k) plans, which allow workers to make choices about retirement savings, jumped from 32 percent to 74 percent over the same period.
With greater decision-making power comes greater stress. "The younger generation worries more about [retirement]," says Marilyn Began, 69, a retired schoolteacher in The Villages, a retirement community near Orlando. "We just kind of figured we'd manage. I would suspect most people in our generation felt that way." Thanks to years of saving, Began and her husband, John, have a healthy nest egg that should last through retirement, she says. "We kind of do what we want now. However, we do live modestly."
To get a better handle on your own situation, consider consulting one of the many retirement calculators that are available online. They'll give you an idea of how much money you need for retirement or, if you're already retired, how long your savings will last. But the calculators come with their own pitfalls. "The big mistake that people make is failing to take uncertainty into account," says Christopher Jones, chief investment officer for Financial Engines, which provides advice to investors. "You want to have a plan that doesn't have you on the street or eating cat food if the market goes down 25 percent over a year or two, which clearly happens. You don't want to assume you'll get 8 percent each and every year."
Jones and others recommend high-end retirement calculators that use so-called Monte Carlo simulations to offer guesstimates about retirement. Instead of just spitting out an estimate of how long your nest egg will last, they consider a variety of scenarios--good markets, bad markets, in-between markets--and offer odds on whether your plan will succeed or fail.
For example, such a calculator might analyze your finances and report that there's a 68 percent chance that you'll meet your goal and a 32 percent chance you won't. "Folks are aiming for plans that have a success rate in the 75-80 percent range," Jones says. "If you try to develop a plan with a higher level of success, it gets very expensive."
Bernicke, the counterintuitive financial planner, likes the Monte Carlo calculators. But he says they make the same mistake as many planners and figure you'll spend the same amount every year throughout retirement. "I don't necessarily think that's a bad thing," he says. "But a lot of people are retiring a little bit later than they could because of these calculators."
Bernicke is not aware of any free or low-cost calculators that don't make the traditional assumptions. (According to Bernicke, some financial companies have adjusted their planning software to take into account his report on spending patterns, but the software isn't designed for the public to use.)
The calculators have another hitch: They can't track every variable in your portfolio, and they may miss hazards that can cause serious damage to your financial future. Mandatory IRA distributions, for example, can take a huge bite by bumping up a retiree's tax bracket, financial adviser Ferri says. "That's what's really going to whack retirees down the road. It's unbelievable when you run the numbers," he says. "For those who have large IRAs, the big hit for them is not medical or housing. It's taxes." But retirement calculators might not pick up on the problem. "There's much more that goes into this than using some simple thing off the Web," Ferri adds.
10 percent solution. If you don't want to hire a planner or dislike wrestling with a calculator, there are a few rules of thumb. Some experts suggest that most people will do fine by simply saving 10 percent of their pretax income for retirement. But even that's debatable: The T. Rowe Price brokerage recommends that its clients invest a whopping 15 percent. "We were trying to find one size that fits all," says T. Rowe senior financial planner Christine Fahlund. "If you just tell people you need to save more, they don't listen to you."
Once you're actually retired, advisers frequently recommend not spending more than about 4 to 4.5 percent of your savings each year. Bernicke, an iconoclast once again, suggests that the number can actually go up to 6 percent.
And what if you do save too much and work longer than you had to? Brokamp, the retirement newsletter editor, says that might actually be fortunate. "Personally," he says, "I think it's not such a bad thing to keep working. You can find several studies that show that unless you're a very active retiree, retirement is not that good for you."
If you do end up with lots of money during retirement, Ferri suggests you do something about it. "People live their whole lives scrounging and scrimping, trying to make sure they take care of themselves for retirement. Now, they've got well in excess of what they need to retire and don't live as well as they could be living given their situation. I keep telling people: Take the trip around the world. .? You don't want to be the richest man in the graveyard."
This story appears in the May 29, 2006 print edition of U.S. News & World Report.