Savings Targets Overstated?

[prubin]

Laurence Kotlikof, Boston Univesity prof, says yes. He suggests that retirement planning tools provided by financial institutions that start with a spending target assumption are off base and in fact have an agenda of creating fear and discomfort. He says they are trying to motivate the purchase of the products of the financial institution is selling. Of course he has a computer planning product to sell. There is more info at:
ESPlanner

I am interested in discussing his approach and reading what others think. I agree with a lot of what Kotlikoff has to say. Taking a lifetime approach to living standard and balancing pre- and post-retirement living makes sense.

 

[ziggy29]

I suppose Dr. Kotlikoff has a generous, secure pension coming to him and is close to collecting Social Security while it's still solvent.

As for the rest of us, we're assuming we're going it completely alone so it would be wise to "oversave" for our own retirement. I suspect I'm oversaving for mine, assuming "semi-retirement" in about 10 years (when I'd be 52).

But yes, I think many people do overestimate their retirement income needs. Maybe they think they're going to want to go out and do a lot of things and "live it up" but decide to be homebodies living a modest life.

Plus, if you're going to make a mistake in planning, better to make a "mistake" that leaves you with more than you need than to make a mistake which doesn't leave you enough.

 

[rs0460a]

My goal....

I would rather die with money than live without it.

No problem with "oversaving/investing" in my world...

- Ron

 

[73ss454]

I would rather die with money than live without it.

No problem with "oversaving/investing" in my world...

As long as you don't have to work till 70 to get it.

 

[prubin]

But yes, I think many people do overestimate their retirement income needs. Maybe they think they're going to want to go out and do a lot of things and "live it up" but decide to be homebodies living a modest life.

Plus, if you're going to make a mistake in planning, better to make a "mistake" that leaves you with more than you need than to make a mistake which doesn't leave you enough.

I oversimplified Kotlikoff's thesis. He argues that using a generic benchmark, such as spending in retirement will = x% of current spending. I agree with him that 1 size does not fit all. He also questions depriving yourself in the pre-retirement years in order to accumulate a nest egg based on a generic benchmark. As I wrote he is also skeptical of financial products vendors motivations. Having said that I am skeptical of his motivation because he sells a software modeling tool which addresses the problems he cites.

I have spent my whole working life living within my means. Spending is function of discretionary income. The 'traditional' retirement planning model is determine what you will spend and then determine how much of a nest egg you will need to provided the 'required' retirement income. I suspect a financial planner would recommend multiple iterations to achieve a balance. My gut feel is that many people become so discouraged they don't iterate, go into denial and become the boomer we read about who has nothing, or very little, in savings. Of course that excludes members of this forum who are dealing with reality.

 

[ziggy29]

I oversimplified Kotlikoff's thesis. He argues that using a generic benchmark, such as spending in retirement will = x% of current spending. I agree with him that 1 size does not fit all. He also questions depriving yourself in the pre-retirement years in order to accumulate a nest egg based on a generic benchmark.

Well, sure. I've figured that we can live our current lifestyle with about 50% of my current annual income. Right off the bat about 25% goes to retirement savings. Another 7% comes from the lack of Social Security and Medicare taxes in retirement income. Another large chunk comes from much lower taxes (and likely being in a considerably lower tax bracket). More still from likely only needing one car instead of two.

I once did the numbers and without cutting back on anything except a few more meals cooked at home, lower wardrobe expenses and only one car instead of two, our expenses would be met with about 40% of my current income. I add 10% back in for health care (since I won't have an employer picking up most of the tab) and get back to 50%.

Most conventional planners seem to think 80% is the answer. Well, given that nearly 30% of my income will be going to max out my 401K, two Roth IRAs and an HSA next year, that's clearly 30% I already don't need for current living expenses. In general, though it seems ironic to a degree, the people who save the most for retirement are also the ones who will likely need a much smaller percentage of their income to live on during retirement.

 

[FUEGO]

Most conventional planners seem to think 80% is the answer. Well, given that nearly 30% of my income will be going to max out my 401K, two Roth IRAs and an HSA next year, that's clearly 30% I already don't need for current living expenses. In general, though it seems ironic to a degree, the people who save the most for retirement are also the ones who will likely need a much smaller percentage of their income to live on during retirement.

The 80% conventional rule of thumb is probably a good rule of thumb for those folks who save very little of their income. If you save 10% of your income for retirement, then you are allocating the other 90% for current consumption/expenditures. Realistically, part of the 90% being "spent" is you paying taxes on income. A portion of this tax bill will go away in retirement when you begin drawing on your savings and retirement accounts. So 80% might be a good guess after considering reduced tax bills. Although healthcare complicated things. Most working folks get free health insurance, and when they retire before 65, they are paying out of pocket for healthcare. So that 80% would have to pay for healthcare, too.

I have definitely noticed an exponential relationship between savings rate and the percent of income needed in retirement. The more you save, the less you spend. Assuming your spending patterns remain similar in retirement, you'll need to save less to have enough to retire on. But it is also a fact that you are saving at a much faster rate, meaning you can retire even earlier. On the flip side, the earlier you retire, the longer you must plan on your portfolio supporting you.

 

[youbet]

Assuming your spending patterns remain similar in retirement, you'll need to save less to have enough to retire on.

It's just as outlandish to assume your spending patterns will remain similar in retirement and pre-retirement as it is to assume you'll need 80% of your pre-retirement income.

Some folks have large work-related expenses that will diminish during retirement. Others have postponed travel, entertainment and other expenses during their working years and will want to catch up. Etc.

A survey on this board showed some folks are spending much more in retirement than pre-retirement, others much less, and everything inbetween. You need to think through your own retirement spending needs and desires and understand that, if you can afford it, you may spend more. Or, for whatever reason, you may spend less.

How that relates to 80% of pre-retirement income I don't know. But, what else is a FA to go on without doing a deep dive into a person's personal desires for retirement spending and their ability to pile up the savings to support it?

 

[prubin]

It's just as outlandish to assume your spending patterns will remain similar in retirement and pre-retirement as it is to assume you'll need 80% of your pre-retirement income.

Some folks have large work-related expenses that will diminish during retirement. Others have postponed travel, entertainment and other expenses during their working years and will want to catch up. Etc.

The mktg collateral for Kotlikoff's 'ESPlanner' software claims that this tool will help you model what you will spend and to perform what-if scenarios. I am thinking of buying the software. If I do I will report my experience.

 

[walkinwood]

I bought ESPlanner some time ago and found it very useful. However, it does have its limitations.

The "consumption smoothing" idea is that we're happiest when our standard of living (annual consumption in $ - excludes taxes, savings ) stays constant. i.e. sharp drops cause pain. I buy into this. I have no desire to scrimp and save today and then spend lavishly when I retire. Or worse still, live the other way around!

So, his program figures out your current standard of living (inferred from your salary, investments & savings), your expected lifetime earnings, and then calculates a constant standard of living to age 100. It takes into account SS, RMD, taxes (fed & local), has inputs for special expenses/income (like health insurance & periodic large expenses, inheritances) property taxes, loans etc. It clearly shows what your tax bill will be each year & I've compared it with Turbotax and it is really close!

From that point, it is quite useful to see how your money would accumulate & how you would spend it. Effects of taking SS early v/s late; timing of tapping into your tax-deferred accounts, changing your standard of living, your children becoming independent, moving to another state, a less expensive house etc.

The limitation I found is that portfolio performance is calculated using a constant percentage. This is obviously not the case. I use very conservative performance numbers to overcome this limitation - but it is a big issue in my mind.

The program does have a monte-carlo version, but I haven't figured out how to use the data it outputs in my real-life situation. It spits out a lot of numbers but its recommended standard of living is too agressive. They know this and have said they're working on a future release that takes users risk profile into account.

Larry Kotlikoff has also written a lot of papers that are available on the net. I've found them to be very interesting.

Regards,

 

[rs0460a]

I would rather die with money than live without it.

No problem with "oversaving/investing" in my world...

As long as you don't have to work till 70 to get it.

Retired this year (age 59)

- Ron

 

[Rustic23]

I always find the conversations on the % of current income you will need to retire somewhat, if not totally, useless. We are currently living on 31% of our last year of w*(k's gross pay. Yet, we are living at the same or slightly better standard of living.

I found far more useful discussions that talk about what you would, not be spending. Things like lower tax, more or less eating out, lower laundry cost, 1 rather than 2 cars, less driving, fewer lunches out, lower property tax, higher health care, more travel, or less travel.

So, while I think many folks may be under saving, and that may be questionable, as I have not seen a good break down as to what is savings. i.e. 'savings rate down' but does it consider retirement plans, which are all savings, (a subject for another thread) I do think people are being led to believe they need more money than they may need.

 

[prubin]

Larry Kotlikoff has also written a lot of papers that are available on the net. I've found them to be very interesting.

Regards,

He participaed in a discussion available as podcast. I found it very interesting. It is at:

Financial Planning Podcast Series

and it is the 1st one entitled "The State-of-the-Art Retirement Portfolio."

Thanks for the info about ESPlanner

 

[rs0460a]

Don't look at gross pay!

I always find the conversations on the % of current income you will need to retire somewhat, if not totally, useless.

Agreed! I retired this year (age 59). The target for my wife/me retirement income was "100% of our final net income" of our final paychecks.

Being that our lifestyle will not change in the early years (including continuing travel to Europe every year) we don't have any "latent desires" that we want to persue. We have lived a good life and have not had any "delayed gratification" that would be done after we retire.

We will continue to buy new cars, live in our home (no relocation or downsize) and still dine out a few times a week.

We realize that that in the future, we will "slow down", but we are not planning on reducing our level of spending just because we retired.

I've run our retirement taxes and we will be at the 15% federal level (our state does not tax IRA's - we paid on the original income over the years). Again, we don't look at gross - just what will be taken out of our respective IRA's (in addition to SS when the time comes). In fact, I'm planning at a 100% taxable SS benefit for the future.

- Ron

 

[ats5g]

I suppose Dr. Kotlikoff has a generous, secure pension coming to him and is close to collecting Social Security while it's still solvent.

AFAIK, Kotlikof has worked at BU for most of his career which has defined contribution plans [403(b)'s with either TC or Fidelity].

The limitation I found is that portfolio performance is calculated using a constant percentage. This is obviously not the case. I use very conservative performance numbers to overcome this limitation - but it is a big issue in my mind.

The program does have a monte-carlo version, but I haven't figured out how to use the data it outputs in my real-life situation. It spits out a lot of numbers but its recommended standard of living is too agressive. They know this and have said they're working on a future release that takes users risk profile into account.

I thought the $200 version of the ESPlanner allowed Monte Carlo simulations with various investment portfolios? No?

Personally, I think it's fascinating that Kotlikoff and friends actually put the theories from Samuelson, Merton, Bodie, etc, to work in a program that the non-financial person can actually use.

- Alec

 

[growing_older]

I'm not sure anyone can plan with the degree of precision assumed in many of these discussions. In any case, I'd rather err on the side of oversavings and have some pleasant surprises or greater freedom, instead of risking problems if things don't turn out as planned. In my case, both a divorce and a stock decline would have wrecked havoc on my plans if they were not "oversaved" and allowed margin for error. In my parents' case, failing health has resulted in higher costs for assistance and help around the house - but being able to pay that higher cost has enabled them to stay active and get to do things they want instead of reducing lifestyle. Doing a moderate amount of living below my means seems both prudent and reasonable. I gain freedom and flexibility in my future through having adequate savings. I give up more frequent new cars or latest gadgets, which are consumer excess I would want to avoid anyway. I'm not feeling deprived by "oversaving" but rather empowered.

 

[UncleHoney]

I wouldn't waste a cent on software. Do a real time test and see what happens. Stash 50% of your income in savings and live on the rest for a few months. If it hurts some, back the savings down to 40% and work with that level for a while.

For the last three years running I saved half my income and lived on the other half and paid all the taxes out of it too. At the end of each year there was still money left to max out a couple of IRA's.

With a little experimenting you should be able to get a first hand look at what it takes to make it during retirement. You may need to make some adjustments due to future healthcare costs and other expenses that may increase when you retire.

Right now we are doing well at the old pre-retirement 50% burn rate. However, the income has jumped to 87% of my pre-retirement gross. And if I take SS at 62, in February, the income will jump to about 110% of my pre-retirement gross.

 

[old woman]

I want to move and everything will change in retirement, what I spend now has nothing to do with what I will spend then. I am not a spender, I like saving money, I don't see that changing. People where I live have an average income of 25K each so I must be able to live on that. Now I spend about 366 a month on utilities/phone/cable but I have no I idea what they will cost there but if people don't have much they can't charge much so I will just budget $500, I will have acreage so if food cost are too high I will grow some food. They have elk and deer herds and we like to fish so we won't starve. We can grow a big garden, a small orchard and a hog, chickens and steers so food shopping would mostly be coffee and sugar, flour and things we could live without. So for $200 a month I could probably get all the paper, soap, and other household stuff and food. My boyfriend will get three tiny pensions a few hundred each and both of us will get SS. I think we could keep both trucks and a boat and live on just the SS checks with no mortgage. I have about 450K but I don't think I will need it and it will be over 500K before we want to retire.

 

[sunshine]

I always assumed the 80-100% for retirement planning was NET income.
In a normal year my GROSS breaks down to 20% 401K, 30% taxes (fed, state, ss, etc), 10% tithe. That leaves 40% to live on.
If my house, car etc. is paid for by the time I retire, expences would be lower. I can't emagine having 80-100% of GROSS at that time to maintain my standaard of living...but 80-100% of NET should be enough.

 

[CyclingInvestor]

If it is overstated, I am glad it is. I could have retired in 2004 with no reduction in spending - my
dividends (minus taxes and health insurance) would have matched my take-home pay (minus my
mortgage, which I paid off to celebrate becoming FI). However, work went very smoothly for 2
extra years, resulting in a 40% increase in my investment income. When I retired in 2006 at 48
this extra cushion removed all potential financial stress from my life, and allowed me to concentrate
on enjoying my freedom.

The $$ I accumulated from the almost stress-free extra 2 years of work was well worth it. The
fact that I will probably never need that money is not relevant. I do not think his product properly
takes this psychological factor into account.

 

[haha]

The $$ I accumulated from the almost stress-free extra 2 years of work was well worth it. The
fact that I will probably never need that money is not relevant. I do not think his product properly
takes this psychological factor into account.

I agree 100% with this. What counts is not just what you are likely to need; but what will happen to you if you turn out to need more than that "likely" figure. If you don't need it great, you have Ben Graham's margin of error. And if you do need it you will have avoided real worry and heartache by being sure that you have it. I think most of us on this board are compulsive enough to want to have this taken care of. I know I am.

Ha

 

[aenlighten]

The variables are too great

to say much about it. Most people save next to nothing because they are poor and will rely on SS alone. Some have ample pensions and don't need to save anything. Savers are inclined to over save because they have to rely on themselves and like being wealthy. I saved between 25% and 50% of income while working, but due to the shortness of my career, it did not amount to over saving at all. My expenses hardly changed after retirement but they are still much less than my working income. We can plan, but many things can throw our plans off track, so those reliant upon themselves should save more for these contingencies.

The point of early retirement is saving early to allow compounding work for you and not have to work.

 

[walkinwood]

I thought the $200 version of the ESPlanner allowed Monte Carlo simulations with various investment portfolios? No?
- Alec

Alec,
The $199 version does include Monte Carlo simulations & you can use a use canned asset classes or create your own. Then assemble them into one of 10 portfolios. You then assign the portfolios to your taxed & tax-deferred accounts. You can change portfolios as you age - for example, to get more conservative.

The outcomes from the MC analysis is useful to see how your AA choices affect the possible outcomes, but the "recommended" living standard is too high. As I said before, they are planning on a new feature which will take into account a users risk aversion to give a more realistic recommendation.

Larry and the chief developer participate in the user forum & they are very responsive to questions, suggestions etc. I find it quite educating. At $199 - its worth the education.

If you register at the site, you can download the user manual which gives you a lot of info on the program. Boy! I sound like a sales rep for ESPlanner - though not a very good one. I'm not affiliated to it in any way.

 

[Gumby]

My plan is to amass a nest egg suffficient to generate 100% of current spending (net of taxes), so that we will not need to change our lifestyle at all. I assume the w*rk related expenses will be replaced with more travel and/or health care. Our spending is relatively constant, while our income has varied up and down (but has always been above our spending).

 

[W2R]

I think the target of retiring on 80% of your income is historical and was intended for those with significant company pensions (which are pretty rare these days).

In modern days when (for many of us) our retirements depend so heavily on 401K's, our effective salary is lower due to the necessity of contributions to 401K, Roth, and savings.

For example, my take-home pay after deductions and TSP is 48% of my gross salary, and most of that goes to my Roth and savings. I presently live on less than 20% of my gross salary, which I suppose would be about 30% before taxes, SS, and so on.

My retirement goal is 45% (before taxes and deductions) of my present gross income. That would give me more money to spend in ER than I presently spend. I like that idea, since I will have more time to spend money; you can't really spend when you are sitting in a #$)(%*& cubicle all day long. Besides, I'd rather have the problem of too much money to spend than too little.