How Complicated a Retirement Plan Do You Really Need?

Retirement planning requires thinking through various variables that are often difficult to pin down. How do you wade through all the possibilities and come out with a simple, actionable plan?

Retirement planning requires adequate thought and planning that takes into account a lot of future variables.

  • Currently, three drivers are changing how retirement planning is being approached.
  • The retirement of Baby Boomers
  • The uncertainty over the future of social security and Medicare
  • The switch from traditional defined benefit pension plans to defined contributions through 401(k)s and IRAs.

In addition, from a health perspective, people are enjoying life expectancies of 78.8 years on average as estimated by the Centers for Disease Control and Prevention. The leading causes of death for men in the US are ischemic heart disease, Alzheimer’s disease, and lung cancer in that order. For women, the leading causes of death in the US are ischemic heart disease, Alzheimer’s disease, and cerebrovascular disease in that order. The most common associated risk factor is dietary risks, but as we choose to lead healthier lives, we are in turn living longer.

Data compiled by the Social Security Administration states that:

  • A man reaching age 65 today can expect to live, on average, until age 84.3.
  • A woman turning age 65 today can expect to live, on average, until age 86.6.

SSA also provides a calculator for life expectancy for those of you that may be interested to see what your numbers look like at this current point in time based on their calculator, which like any estimation is simply just that.

In the 1950s, Modigliani and Brumberg, proposed what is usually regarded as the standard model for how individuals tend to save for their retirement years, wherein younger households tend to have negative savings due to their lower stage of income coupled with the high expenses of education and a household. Those in the middle period of the life cycle are saving for retirement and working to pay down their debts and once in our post-retirement years we re-enter a period of dis-saving. Throughout the cycle the goal is to keep the marginal utility of consumption constant via borrowing early on and spending at stages of higher income.

However, the actual amount of households believed to be on track for an adequately predicted retirement ranges from 30-80% in some studies, which is a wide variation.

One explanation for this variation by Kim et al, in their work provides further support for the role of education and actual saving. Their study observed that households with college educations are more likely to have an adequate retirement when compared to those with less than a high school education. In addition, those with financial planning incorporated into their strategy were also more likely to have adequate retirement when compared homes not utilizing a financial plan in the former of an advisor or assistance. The estimates also put the median fee for a comprehensive financial plan to be around $2,487, which may preclude a lot of these households from having access to these services.

Proposed solution: This paper calls for the design of financial education materials for low reading levels to help increase the level of retirement adequate households.

Once individuals enter their retirement years spending data reveals that individuals tend to spend more early in retirement, which makes sense, as they are still more physically active and decrease with time.

Thus, the traditional assumptions of spending habits have been criticized over the years for assuming that all living expenses in retirement increase at the rate of inflation, estimating retirement spending with a fixed pre-retirement spending percentage, and not considering contingencies like long-term care.

The following are a few of some alternative retirement plans have been proposed along the way:

One such plan is the Age Banding Model that is proposed by Basu to reduce estimation errors and take into accounts aspects like long term care. You can access this article through the Association for Financial Counseling and Planning Education.

The Changing Consumption Model proposed by Blanchett estimates that the true cost of retirement is unique to personalized circumstances and accounting for these is likely to result in lower amounts than those from tradition models. You can access this article through Morningstar.

The Reality Retirement Planning model proposed by Bernicke assumes that a household's "real" spending will decrease incrementally throughout retirement. You can access the article, published in the Journal of Financial Planning, here.

In summary, the key to each of the models is to have an actual plan that you are implementing and most importantly one that you can thoroughly understand.

How are you approaching your retirement Planning?

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Sources:Love et al. Do households have enough wealth for retirement? Finance and Economics Discussion Series.CDChttps://www.ssa.gov/planners/lifeexpectancy.htmlCCM. Blanchet 2013Association for Financial counseling and planning educationJournal of Financial Planning