By Joe Tomlinson
In March 2012, I participated in a Washington D.C. roundtable on the subject of the “Impact of Running Out of Money During Retirement.” The roundtable was sponsored by the Society of Actuaries, Urban Institute and the Women’s Institute for a Secure Retirement (WISER). Participants included actuaries, members of the academic community, individuals with a business interest in the retirement market, researchers and officials from government agencies, and researchers from “think tank” organizations.
The stated task for the roundtable was: To explore what we know about post-retirement pathways leading to and causes for retirees running out of money today, to identify added research needed, and to identify actions that can help individuals avoid that situation in the future.
A report on the roundtable will be made available later this year.
The general task for the group was broken down into 12 questions. Each participant was asked to submit information in advance, which was shared with the group and laid a basis for the conversation. I chose to address the following question, based on my experience as an actuary, financial planner and retirement researcher. This article shares the information I submitted and represents my opinion, and not the discussion of the group.
What alternative courses of action would have produced a better result? And how do we encourage people to take better courses of action?
This question relates to two different types of problems:
- People who arrive at retirement without sufficient savings or other resources to support retirement.
- People who have sufficient resources, but don't utilize them in the best way, and run into problems.
Finding ways to cure the first problem has been much discussed, and certainly represents a challenge, given that middle class wages have remained stagnant in real terms for at least a generation. Households have coped by working longer hours, having both members of couples work, and by leveraging with credit cards and home equity. However, those sources of additional funds have been tapped out, so it is not surprising that, in the present environment, people are having a hard time saving enough for retirement.
But even those who do save enough face daunting challenges in making the best use of those savings to support retirement. In this article, I will concentrate on this issue.
It can be an overwhelming task to determine the best way to manage savings in order to fund a retirement over an uncertain lifetime. Even experienced financial planners disagree on such fundamental issues as:
- Safe withdrawal rates
- Methods of managing withdrawals—systematic withdrawals, separate management of required and discretionary expenses, or time-based segmentation (buckets)
- Asset allocation—stock-heavy for higher returns or bond-heavy to minimize volatility
- The use (or non-use) of annuity products.
However, despite this confusion among advisors (which should lessen over time as more research gets done), people planning for retirement can still benefit by getting advice from professionals. But then there's the question of how to go about obtaining advice that is of good quality, unbiased and reasonably priced. Unfortunately, if a person just uses the Internet or the yellow pages to look for advisors, there is a much better chance of being ripped off than of obtaining trustworthy advice. Combine this issue with the problem of cognitive decline as people age and the challenges loom even larger.
These are some of the problems (in some cases overlapping):
- Middle-income individuals and couples, who need help the most, are underserved in a market where being a successful professional means moving to upscale clients.
- It is actually more challenging and complicated to do planning for people of ordinary means than for rich people. It could be said that it is easier to do retirement planning for Bill Gates than for someone with $250,000 in savings. Anna Rappaport has made the point that the retirement planning issues for low income vs. middle vs. rich are completely different. (The Retirement Income Industry Association—RIIA—uses a perhaps more useful categorization: underfunded, constrained and overfunded.) For the upscale market, accumulation planning and decumulation planning are not that different. For example, upscale clients have less need for products with guarantees—like annuities. They can get by with the same types of investments as in the accumulation phase. For the low- and middle-income families, the ballgame changes completely. It becomes a huge challenge to provide planning for middle-market clients that adequately recognizes individual needs, and does so in a cost-effective manner.
- The delivery of financial services provides many instances of market failure because of asymmetry of information—buyers vs. financial salespeople. (An example is that high-commission/high-priced annuity products sell much better than low-priced products.)
- Too often, in the middle market, the delivery of advice ends up being no more than the salesperson pushing his or her favorite product rather than providing a service that recognizes the needs of the individual buyer, and offers alternatives.
- Buyers come to the purchase of financial products with a whole host of cognitive biases that affect choices and decision making (see Daniel Kahneman's book, Thinking, Fast and Slow). Unfortunately, the financial services industry has not done very much to help people overcome these biases and make better decisions (too few examples of Richard Thaler's book, Nudge in action). There are far more examples of financial service companies exploiting the biases. The promotion of active investment management with higher costs and poorer performance than low-cost index funds is an example.
- From the perspective of the financial services industry, there is an excess of manufacturing capacity and a scarcity of productive salespeople. Insurers and investment companies often end up viewing the salesperson as their customer, and catering to the needs of the sales force. Attempts to introduce lower-cost delivery options are often thwarted by the power of the sales forces.
Fixing the Problems
There are initiatives attempting to provide better retirement planning services, with a focus on middle-market needs: examples include Garrett Planning Network, Kent Smetters’ Veritat, Kelli Hueler of Income Solutions® and her work with employer plans, services offered by Vanguard, Fidelity, Schwab, eTrade and TD Ameritrade. However, the needs are much greater than the initiatives can deal with. Also, for many of the initiatives, there is a bias favoring regular stock and bond investments, so products with guarantees like annuities are not recommended.
There are a number of potential alternatives to consider that may address parts of these problems. Possibilities include:
- Doing more to encourage employers to provide advice services by removing liability barriers and possibly offering incentives. However, this may have more potential with large employers than with small employers.
- Providing tax subsidies for those using financial advice. Yale professor Robert Shiller has proposed this idea.
- Implementing innovative programs like the Security Plus Annuity—a program proposed by Pamela Perun and colleagues at the Aspen Institute's Initiative on Financial Security—that would utilize Social Security offices to both encourage optimal timing of Social Security claiming and offer add-on annuities as well.
- Perhaps considering a national program like the UK's NEST (National Employment Savings Trust), which will:
- Offer a standardized and simplified menu of funds for employee retirement savings
- Require contributions from employers, employees and the government (with automatic enrollment, but allowing opt-outs).
It is worth raising the question of whether a NEST-like program would be more effective than Auto-IRAs proposed by the current administration. We should also consider whether we need a mandated solution like Teresa Ghilarducci's Guaranteed Retirement Accounts (GRAs), described in her book, When I'm 64.
- Making better use of social networking as a medium for discussing financial issues. Groups like Bogleheads work well for sophisticated do-it-yourself investors. Perhaps, over time, applications will develop for the average investor. Standardization and simplification, as will be done with NEST, would create more opportunities for shared interests in social networking.
- Finding better ways to take the vast amount of academic research devoted to retirement planning issues, and connecting it to the development of practical applications. We are long on ideas and short on implementation.
It would probably make sense to try initiatives in pilot programs, carefully monitor performance and adjust, before going to full national rollouts. The problems are big, but there are solutions waiting to be tried.
Joe Tomlinson, FSA, MAAA, is president of Tomlinson Financial Planning, LLC, and can be reached at email@example.com.