The Overfeathered Nest Egg

Critics say financial-planning calculators encourage employees to save too much.

What the calculators fail to consider is actual spending patterns, say critics. Many models assume retirees will spend between 70 and 90 percent of their preretirement income, adjusted for inflation, annually. Yet, data from the U.S. Bureau of Labor Statistics’s report “Consumer Expenditures in 2005″ shows that people tend to spend less as they get older (see the chart at the end of this article). Average annual expenditures for people between the ages of 45 and 54 was about $56,000. That number dropped to $39,000 for individuals between 65 and 74, and to $27,000 for those 75-plus.

In addition, the calculators don’t consider the natural ebb and flow of spending leading up to retirement. Most people save less as they’re raising a family, but that changes once day care and college expenses disappear, Kotlikoff notes. What’s needed in the models, he says, is so-called consumption smoothing, so that investors can evaluate certain life decisions and their impact on living standards. And that means introducing such variables as marital status and geography into the equations.

Typical online calculators do not use such data. But to get a more accurate picture of what is needed in retirement, such variables need to be used in Monte Carlo simulations — which randomly and repeatedly generate values for uncertain variables, says Kotlikoff. That way, employees can see how their retirement accounts change with the ups and downs of the market. For example, an employee who retires in an era of high inflation and poor capital markets would see his ability to fund retirement substantially compromised. Other models would show the range of potential outcomes compared with current living standards.

For their part, Fidelity and T. Rowe Price — both of which offer Monte Carlo versions — point out that the online calculators should be viewed as starting points, not full-fledged plans. Retirement, says Ritter, can last a long time and be affected by numerous variables, particularly health-care expenditures. What the calculators present are savings plans that are realistic, yet conservative. “You face a risk of a very negative outcome if you’re not conservative,” Ritter says.

Just Do It

Several more-dynamic calculators do exist. Palo Alto, California-based Financial Engines Inc., for example, sells a technology that models investment returns, which starts at $150. Pivot Point Advisors LLC, in Bellaire, Texas, offers a free Monte Carlo–based program on its Website that runs about 1,000 iterations of actual returns over the past 30 years to determine possible future outcomes of a portfolio. And Kotlikoff has developed his own model, ESPlanner, a software application ($149) that asks users to input data on child care, college, medical bills, vacation homes, and geography, among other factors.

Questions about the relative merits of competing products aside, the real issue is whether employees will avail themselves of any financial-planning tool at all. Despite the availability of such dynamic models, most employees take only a few minutes to calculate what they need in retirement, says David Wray, president of the Profit Sharing/401(k) Council of America. Others don’t use calculators at all. “Most employees seem to think retirement will take care of itself,” says Ed Morgan, CFO of Guaranty RV Inc., a group of dealerships based in Junction City, Oregon, which now automatically enrolls new employees in the company’s 401(k) plan, deducting 3 percent from their salary.

Very few employees, it seems, are in danger of saving too much, and to date no one has actually ever complained of having oversaved. Instead, as baby boomers rewrite the meaning of retirement, the financial-planning community is struggling to recalibrate how much it will cost. “We haven’t had a whole generation of people accumulate dollars in their 401(k) plans and live to their 90s,” says Wray. “Most of this is hypothetical.”

Karen M. Kroll is a freelance writer based in Chanhasen, Minnesota.

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