Is Retirement Advice Biased Against You?

Standard income-replacement goal seen by one expert as a scare tactic to sell more investment products.


Have you ever seen an investment firm message that our retirements are on track and we should just head to the beach? Me neither. Up to a point, a certain amount of "sky is falling" rhetoric is not surprising. However, one critic of standard investment advice thinks there is more going on here.

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Austin Nichols is a senior research associate at the Urban Institute, a Washington, D.C., think tank that does a lot of research on economic issues. In a recent paper, Nichols takes aim at the notion that people should try to achieve retirement incomes that are roughly 80 percent of their pre-retirement incomes.

This is a common goal in retirement planning, and it makes a lot of sense at first. The thinking is that people have developed some balance in their income-spending needs through the years, and that their incomes near retirement are thus sufficient to meet their needs. After they stop working, their income needs will decline. They will need to set aside less money for retirement savings, for one. Also, their tax rates are likely to fall, and so will their work-related expenses.

That, at least, is the common wisdom. But Nichols says it's just flat wrong. To achieve a retirement income goal of 80 percent of pre-retirement income would require a large amount of savings, he says, even for people who begin when they're young. And if people wait until their 40s, say, to get serious about funding their retirement needs, there is no way they can achieve an 80 percent target.

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"To hit a target of 80 percent of pre-retirement income," his paper says, "workers retiring at 62 ... who began to save in 2010 at age 45 might need to save 65 percent of their income." Besides being impossible on a practical basis, saving that much money would mean that a person was spending only 35 percent of their income. When they retire, by contrast, they would find themselves with 80 percent of their income to spend—an enormous and probably unneeded boost in their living standard.

"They should be saving less today and consuming less when they retire," Nichols says. "But one cannot optimize by targeting a percentage of gross pre-retirement income. Instead, one must target spending."

Looking at spending capabilities, a lot of the fear about retirement readiness disappears. Yes, some people will have tough retirements. But the odds are that they have had a tough time making ends meet all their lives. Being retired won't magically change their financial situation. The story for most people, however, is different and more positive.

Research by University of Wisconsin economist John Karl Scholz, among others, finds that roughly 75 percent of Americans were adequately prepared for retirement several years ago. In other words, they had accumulated enough assets to maintain their pre-retirement living standards after they retired.

In a late 2009 paper he co-authored with William Gale at the Brookings Institution and his University of Wisconsin colleague, Ananth Seshadri, the three say that taking a look at the facts of Americans' wealth holdings "does not seem consistent, in our view, with dire assessments of poor financial preparation."

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One unknown factor is how much this conclusion has been affected by the recession, related investment losses, and collapse of the housing market. People may have reached their own anecdotal conclusions. But economic researchers depend on surveys of large population groups taken over many years to reach their conclusions.

For his part, Nichols tells U.S. News, he simply wants to set the record straight on "something that has been bugging me for years. A lot of people have used these kinds of rules of thumb about how much you have in retirement in relation to their income. When I took a more detailed look, I was shocked to find that all of the official advice is the same." Even the federal government issues this advice, Nichols says he found.

"You want to equalize your spending before and after retirement, not compare your draws from retirement savings with your pre-retirement income," he says. "You want your spending the year before you retire and spending in the year you retire to be roughly equal."

Investment firms, he says, are complicit to some extent in misleading people. "They do try to make people scared about how little they have saved up, and convince to save more than is optimal," he claims. People may have a lot of financial exposure to an unexpected job loss or huge medical bills, he says. "But I think, by and large, they are prepared for retirement."