Monday, March 7, 2016

Retirement Savings and Annual Spending

The Motley Fool (TMF) recently published a column entitled, “The Average American Household Approaching Retirement Has This Much Saved Up.” It’s pretty discouraging.

TMF took data from a GAO report that includes the current financial status of households between the ages of 55 and 64. (A link to the report is provided in the TMF column.) They found that 41% of the households in the study had been unable to save for retirement directly though many of those have homes with paid-off mortgages and about a third have pensions.

TMF provided the following graph in that column, showing the distribution of retirement savings within that 55-64 age group. Keep in mind that some of the group have nearly reached retirement age while the youngest have another decade or more to save.

Ignoring the 41% of households with no savings and considering only the 59% with some savings, the Motley Fool produced the following chart showing median savings of just over $106,000.

Wade Pfau’s Retirement Researcher website includes a dashboard that shows the current payout of annuities, TIPs bonds, systematic withdrawals, and other distribution methods. It currently shows the payout for a 65-year old couple from a life annuity adjusted for CPI-U (inflation) with 100% survivor benefits to be about 3.85%. Wade's current estimate for the payout of a “4% Rule” spending regime is about 2.92% (the “4% Rule” is currently a little less than a “3% Rule”).

Annual income implied by median retirement savings is only $4,085 from an annuity and $3,098 with 4% Rule.
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It's interesting to look at the savings in the Motley Fool chart in terms of the income that those amounts imply for a life annuity and for “4% Rule” spending. As the following chart shows, the median annual income implied by the TMF chart is only $4,085 for households that buy an annuity and $3,098 for households that go with the “4% Rule”. That’s not a lot of income. Of course, some of these families have pensions, some could borrow against the equity in their homes, perhaps through a reverse mortgage, and most will have Social Security benefits.

Realistically, families that have saved less than the median savings would probably be better off using the savings for emergencies rather than annuitizing them.

As for retirement savings, while saved amounts seem small for most households, the amount of annual income that could possibly be generated is even more discouraging for more than half of 55-64-year-old retirees today.

To get a quick estimate of your possible annual spending, divide the amount you hope to have saved by your retirement date by 34 if you plan to spend systematically from an investment portfolio, or by 26 if you plan to purchase an annuity.

If your calculated spending is disappointing, Wade Pfau has recently written extensively about reverse mortgages (download PDF) and their potential to bail out under-savers. He adds that "there is great value for clients to open a reverse mortgage line of credit at the earliest possible age."


  1. Hi Dirk, yes the study is quite disturbing! The lack of savings - or even awareness of what one needs to save - is astounding to me.

    I did want to point out that Wade, Dr Mitchell, and I did a comparative study between immediate annuities (SPIAs) and portfolio generated income in JFP Apr 2014. We found that a SPIA will always generate more income INITIALLY. However, over time inflation erodes the purchasing power of those dollars so they buy less goods as one ages. This is rarely pointed out in comparisons between annuity income and portfolios - so I wanted to highlight it for your readers. The conclusion was that, in today's low interest rate environment, waiting until one is older (i.e., with fewer years of exposure to the eroding power of inflation) does it make sense to get an annuity for income. Although inflation is low now too, inflation and interest rates tend to correlate and go hand in hand.

    A great post, as always, Dirk!

    1. Thanks, Larry.

      The SPIA payout rate from Wade's dashboard is adjusted for CPI-U. A non-inflation-adjusted SPIA would pay out more initially, but as you note, would lose to inflation over time.

      I tend to think that buying an annuity later is preferable, but not just because of inflation. Delaying buys you time to learn more about how your retirement is going to develop over time and may enable you to make a better decision. As they taught us in grad school, "don't make a decision until you have to."

      My main point was that the large majority of households don't end up with much retirement savings and when you consider the current high cost of income, it's even more alarming.

      Thanks for adding to the discussion!

    2. Dirk, a couple of articles looking at research as to why younger people may not be saving enough for retirement too (FYI):

      Student debt: and what they'd do to get rid of the burden

      Gen X-er's are the most stressed about it too (w/ stats as to how many are seeking advice, etc).

      It really is an issue, especially for those who decide to overpay for an education and then don't get the salary sufficient to pay for that education.

    3. Thanks, good stuff for younger workers!

      For the 55-64 age group in the above charts, however, the biggest problem was likely stagnant wages since 1964.

  2. If anyone is having trouble posting a comment with IE 11 (or any other browser, for that matter), please email me at Larry was having a problem but switching to Chrome worked.



  3. Why divide by 34 for an investment portfolio? Shouldn't it be 25 considering the 4% rule?

    1. Good question!

      If you read Wade Pfau's work and check out the dashboard I mentioned at his website, you will find that in today's low-interest rate environment, the 95th percentile sustainable withdrawal rate is close to 3%, not 4%.

      Constant-dollar spending schemes are generally referred to as the "4% Rule" because the initial studies showed that historically the SWR was 4%. That appears to be too high a prediction in the current environment. Awkward as it may sound, the "4% Rule" is currently a "3% Rule."

  4. BTW, I think you follow Michael Kitces’s blog. A recent article might be worth a comment on your blog, for those readers who don’t follow Michael. The study referenced certainly points our the importance of checking out your advisor/firm. Here is the link.

    1. Michael's is one of my favorite retirement blogs. I highly recommend it to everyone.

      If you watch the Twitter feed on my blog, you will see his tweets pop up often.

      As Michael notes, there do seem to be a lot of shady financial advisors out there. To that, I would only add that there are many scrupulous but mediocre advisors. You have to be on the lookout for both.

      Thanks for writing.

    2. Dirk,
      Thanks for the kind words.

      Strictly speaking, I actually believe that the scrupulous-but-mediocre advisors is the bigger of the two problems. But that's a conversation for another day. :)
      - Michael

  5. I work with a number of millenials, all of whom have university degrees, many of them in the sciences. I have found that they are generally very uninformed about savings rates for retirement and the various vehicles that can be used. Our company has a pretty generous ESOP plan and smaller matching 401k contributions, so they are unlikely to end up in too much trouble, but the general lack of interest in the topic is disturbing. In general, there is a pretty low level of knowledge. Fortunately, the default investment is now Vanguard Institutional TD funds, so they can actually be in a pretty good place by doing essentially nothing other than making modest contributions.They would generally be completely lost in a less "paternalistic" corporation.

    For older workers, I would say that the level of knowledge is generally a state of confusion unless they are working with a good RIA type of planner. The barrage of conflicting information from the financial industry has generally made it difficult for people to become well-informed, even if they put a modest amount of effort in.

  6. I would be more inclined to give those young whippersnappers a good tongue-lashing were it not for the fact that I didn't know (or care) diddly squat about personal finance until I earned my MBA in my early thirties. (I had an undergraduate degree in computer science.)

    I keep telling my wife, "the problem with kids today is they're doing the same stupid things I did when I was their age." Unfortunately, there was no one encouraging me to save. Fortunately, I did it, anyway.

    There is a barrage of conflicting information in the finance industry, some unscrupulous planners and a lot of plain mediocre planners. I try to organize the information with my blog and make it make sense to non-financially oriented people, but I do agree with you.

    Thanks for chiming in!

  7. I would like to comment here, but I want to begin with the question of what I have found to be most confusing in financial planning.

    What is most confusing is "the barrage of conflicting information" that you note. I too began saving in my thirties, as graduate student -- primarily in response to a radio program that I heard on my commute to the University. The major theme of that program was a constant drumbeat of criticism of the "variable annuity". The SPIA was also denounced -- especially if not inflation indexed.

    Now, thirty years later, I realize that the program was not particularly sophisticated (I read your fine blog, Kitces, Pfau ..)

    Pfau has talked about the irrational decision made by those who reject annuities given the math (you provide an excellent example above). As I recall it was labeled the "annuity bias" or something along those lines.

    But biases are real behavioral issues. I don't LIKE insurance companies ... after all, they spend a lot of money trying to sell me what I believe to be a bad product (the variable annuity).And then there is the matter of greed and fear, or as I prefer, hope and fear. I would rather "hope" that my unspent resources, if any, could be given to a charitable cause that I support rather than become an insurance company asset.

    So, I settle for today's lower "4% rule"...even though I know that it might be "irrational" At this point it might be relevant to end by noting that when "personal biases are added to conflicting information" things are muddled indeed. No wonder so many find it difficult to save, especially given our cultural bias for buy and enjoy NOW!

    1. “Irrational” means not logical or reasonable. I don’t believe there is anything irrational about your avoidance of annuities. You simply choose to make a different bet.

      Either a bet on annuities or a bet on the market could be a winner for you, depending on your future portfolio performance. No one can predict that. Pfau, et. al., are simply saying that bets that include some amount of annuitization tend to do better than those that don’t (which is why I personally annuitize some of my savings). They’re not suggesting you annuitize everything because they, too, are unsure of which will do best. That’s what floor-and-upside strategies are all about.

      No one likes insurance companies, but that doesn’t mean you’re not better off with some of their products. I don’t like insurance companies, but I insure my home, my cars, and liability. If you avoid annuities because you think the market is a better bet, that’s a rational and defensible choice. If you avoid them because you don’t like insurance companies, even though you think annuities would improve your odds of success, that might be irrational – the old "cutting off one's nose" thing.

      Thanks for writing!

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