Retirement Planning Inadequacy Is Overstated

The Problem

There isn’t a week that goes by without a story in USA Today or the New York Times about how unprepared people are for retirement.  While the charge is true, the retirement planning dearth
is overstated.

Note that journalists really don’t know anything about the topics they write about.  That is not a criticism; it is simply true. When they write about retirement planning, the journalist must get information from others  because the journalist majored in journalism, not finances.   The journalist interviews “experts” for the information to write articles.  Specifically, the journalist interviews retirement planners and investment firms to write about retirement planning.  Those interviewed have a vested interest to tell readers that their retirement planning is inadequate and to invest more (with their firm of course).  And not surprisingly, these commentators think alike and offer similar comments.  There is a monopoly of thought about retirement planning in the financial services industry and it goes as follows.

In 1998, some academics wrote a piece referred to as the Trinity Study.   The study had a few conclusions, two of which were:

The Proposed Solution

1. Investors need to have 50% of their money in equities through retirement if they want any chance of their money lasting through a lifetime. (People in the insurance industry will tell you that once you retire, you should buy their safe annuities and take no risks in the market. The Trinity Study shows why this is very bad advice).

2. That the “safe withdrawal rate” from a portfolio should not exceed 5% annually.  If it exceeds 5%, the chance of the portfolio running out prior to death is significant.

As a consequence of point 2 above, retirement planners now base their projections using this 5% figure and a potential life expectancy beyond age 90.  The US National Vital Statistics show that if you have lived to age 70, you have an 11% chance of living to age 95!  Therefore, judicious retirement planners advise having a sufficient nest egg to last all of those years.  The longer you live, the more money you need at the time of retirement.

My Solution

But for my personal planning, I only plan to age 70.  Not because I think I will die at that time but because I will shift all the risk for my longevity to the insurance industry.  I will maintain a large portion of equities until then using a bucket strategy (covered in a future post) and then, about age 70, switch my retirement portfolio to immediate annuities. Here is the comparison of the conventional wisdom for retirement planing and my plan:

1. Listen to a retirement planner.  If I need $50,000 annually from my portfolio, I need to retire with $1 million, limit my withdrawals to 5% annually and hope I don’t live too long,  so say the financial planners.

2. My plan is to shift risk to the insurance industry by placing all of my funds in life annuities at age 70.  Based on today’s rates (which, in line with general interest rates, are low), a 70-year-old man investing $1 million would get $85,080 annually (an 8.5% cash return).  The entire longevity risk is shifted to the insurance industry and the income is higher than would be enjoyed from a typical “retirement plan.”

Here are all of the responses that the financial services industry would counter to my retirement plan:

1. But you wont have any hedge against inflation.
Answer: if I have 8.5% coming in ($85,000 vs the $50,000 from the typical retirement plan), I can put some of my excess away in the early years (e.g. age 70-75) and build a financial cushion.  Answer #2 to this comment: I can sell my home and move to a less expensive area and free up investment cash from the equity. Answer #3: I can take a reverse mortgage. Answer#4: How much money do you think I’ll be spending when I’m 80? Answer #5: I’ll be eating more porridge by then and less filet mignon and the porridge is less expensive.

2. But what if the insurance company fails
Answer: I will spread my money among the safe insurance companies and since I can interpret a balance sheet (which sadly, most financial advisors cannot), I can pick the safe insurance companies. While I don’t have global information about insurance company failures, to my knowledge no one in the US has lost money in an immediate annuity in the last 50 years and possibly longer.  Please post a comment below if you have different data.  Please skip discussion of a Black Swan event.

3. But nothing will be left to your heirs
Good.  They need to learn to make their own money and not get infected with the viral cancer afflicting too many baby boomers who still suck on their retired parents’ teet. The trade off of leaving nothing to heirs is the comfort of knowing I will never outlive my money (and the possibility the heirs might just become financially productive themselves).  Life annuities pay income for LIFE so I will selfishly be in good shape.

The additional comfort is that rather than needing a retirement plan with contingencies until I am age 95, as the retirement planners tell me I must do, I only need to plan to age 70 and then let the insurance companies take the burden.

4. If it were such a good idea, everyone would be doing it
Hardly.  Most people are financially illiterate, even most financial advisors.  If you doubt this, ask your financial advisor to show you his net worth statement.