Wednesday, May 20, 2015

Retirement Expectations: A Reality Check

I got into an interesting discussion with some friends on FaceBook the other day about what Americans can reasonably expect from retirement. It made me think about what my own expectations had been and I realized that I had never really had many.

(Embarrassing full disclosure: I never thought much about retirement at all until I was about 50.)

Oh, I saved a lot of money in defined contribution plans over the years, but not because I was thinking about the future. I had a high-paying career and the tax deferrals were instant gratification. I knew down deep that I would have to pay those taxes someday, that they were merely deferred and not avoided, but I didn't give that much thought. I was interested in the current year's tax savings.

Surely everyone knows by now that a large majority of Americans under-save for retirement. Baby Boomers haven't saved enough and they get most of the venom from the press, but younger cohorts are in even worse shape.

How badly prepared are we?

The Employment Benefits Research Institute (EBRI) has prepared a "Retirement Readiness" report since 2003. A recent report (download PDF) from 2012 states,
"EBRI’s updated 2012 Retirement Security Projection Model® finds that for Early Baby Boomers (individuals born between 1948–1954), Late Baby Boomers (born between 1955–1964) and Generation Xers (born between 1965–1974), roughly 44 percent of the simulated lifepaths were projected to lack adequate retirement income for basic retirement expenses plus uninsured health care costs."
How do we compare to the rest of the world?

Natixi Global Asset Management produces a ranking of retiree welfare by country (PDF). In 2015, they rank U.S. retirees 19th in the world, slightly worse than France, slightly better than Slovenia, and four rungs below the Czech Republic.

A critical factor in the cost of retirement, of course, is longevity. The longer we live after we retire, the more our retirement costs. I suppose there is some "good news" in our world rankings, in a morbid sort of way. The CIA Fact Book ranks the U.S. 49th in life expectancy, slightly worse than Portugal, slightly better than Taiwan. (You can find the full ranking here.)

At least we don't have to fund Japan's retirements, with life expectancies of 84 years, let alone Monaco's nearly 90.

So, the problem that has evolved, for both Baby Boomers and younger cohorts, is that advances in medicine have extended our life expectancies significantly since World War II (though not as far as Portugal's, let alone Monaco's) and that has significantly increased the possible cost of retirement. Unfortunately, longer life spans increase the number of years at the end of our lives, while our earning years still end around age 65. We have the same length careers to fund potentially much longer lives.

For someone who lives to 95, that means perhaps 70 years of adulthood will have to be funded by about 40 years of working career. We get some help from Social Security retirement benefits, a few of us have pensions, and we can leverage time and our investments if we start saving early. But that's still a pretty tall order.

Wade Pfau wrote a paper in 2011 entitled, "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle." (PDF) He calculated that the amount of our paychecks that we needed to save historically sometimes approached 25% for a household that needed to replace 70% of pre-retirement income with 30 years to accumulate savings. That's a lot when a household is doing all they can to raise a couple of kids and put them through college. (For some periods, the saving requirement was significantly less, but we can't know that in advance.)

That brings me around to how to think about retirement savings. We shouldn't think about retirement savings as this year's tax break, as they were marketed to Baby Boomers, or as a way to make our retirement years a little more golden.

We should think about retirement savings as transferring some of the wealth from those 40 working years to fund the last 30 after retirement. It isn't fun to think about the fact that in addition to supporting our families before we retire – which probably seems like an enormous challenge on its own – we need to earn enough to also support ourselves and our spouses for what could be a very long retirement.

If I were giving my twenty-something children retirement saving advice, that's what I would tell them. Save like you understand that the money you earn today has to pay the bills today and the bills after you retire. Because it does.

I would also tell them that funding a decent retirement in the U.S. is an extreme challenge that requires sacrifice while they are working and a great deal of good luck throughout their lifetimes.

Many households simply won't earn that much, or be that lucky, and that is the reality that ERBI is reporting. It's not the prettiest picture, and it's one you can't wish away.


  1. The CIA life expectancy table you posted and discussed above is pretty much irrelevant to retirement planning. A major reason that the US does so poorly in international comparisons of life expectancy is that our infant mortality rate is disgracefully high in the light of our relative affluence. However, since infants are too young to do any meaningful retirement decision making, the tables linked above are pretty irrelevant. Tables of life expectancy distributions conditional on having some reasonable adult age would be more relevant. There is some pretty interesting international data about life expectancies conditional on reaching older ages here.

    1. I agree, but I did not suggest that these sources be used for retirement planning. Your link looks like a great resource for anyone seriously interested in international life expectancy, but like you, I don't see the relevance to actually planning a retirement in the U.S. The CIA table was provided as background information.

      Thanks for the link!

    2. I did glance at the book at your link. You seem to be familiar with international life expectancies, so maybe you can answer a question for me. Doesn't Figure 2-1 at your link, a scatterplot of GDP versus life expectancy at age 50 for 2005 show pretty much the same ranking for the U.S. as the CIA ranking of life expectancy at birth?

      I count 21 dots above the U.S. dot, which would put us at 22 instead of 19.

    3. Sorry to take so long to reply. The CIA ranking of life expectancy at birth has the US at 49th, not 19th, so in fact we are doing relatively better at living longer once we have gotten past infancy. The elephant in the room is that child poverty (i.e., poverty in young households with children) is a far more serious problem than elderly poverty in the USA. Our safety net for the elderly is relatively much better than our safety net for children.

    4. OK, so I now think you and I are in sync. I agree that childhood mortality in our country is a disgrace, and that American life expectancy from birth is extremely poor compared to other countries (49th).

      My disagreement is with your initial statement that "Tables of life expectancy distributions conditional on having some reasonable adult age would be more relevant [than the one I provided]."

      The table I provided in the post is, in fact, based on the conditional probability of, as you say, "reaching older ages." As your link confirms, had I included infant mortality, we would rank 49th in the world, not 19th.

      I also disagree, as a result, with your comment that the data I provided is "pretty much irrelevant to retirement planning." It is highly relevant to retirement, though not granular enough to be used for an individual's retirement plan, but that isn't something that I suggested.

      While I agree with your position on infant mortality, it is a bit off the topic of retirement. Still, I think it's an important thing to know and I never mind getting off the path a bit to spread good information. (My son has a Masters in Public Health, so this has been a topic of brunch discussions.)

      Thanks for reading my posts and taking the time to share some important information.

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  3. Thank you for answering the questions

    1. You're welcome! It's my favorite part of the blog.