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How Much Money Will You Need for Retirement? More Than You Think
What you don't know can't hurt you, according to the old saying. When it comes to retirement planning, though, the old saying doesn't apply.
Most people understand, at least superficially, that the sooner they begin planning for retirement the better.
Putting money aside now rather than later means that you will have more assets in the long run.
What many people don't know, however, is the amount of money they will need to live on in their golden years.
To be specific, they seriously underestimate the possibility that they may outlive their assets,
according to experts at Wharton. Indeed, Olivia S. Mitchell, professor of insurance and risk management,
has this strong dose of advice: It may be a good idea for people to assume that they will need the same
level of income during their retirement years that they need now.
Mitchell, executive director of Wharton's Pension Research Council, says people tend to
focus on the "accumulation phase" of retirement planning – those years on the job when they
are socking away money and making decisions as to how that money should be allocated among stocks,
bonds and cash investments. What they do not give much thought to is how much income they will need after they stop working.
"A lot of people don't have very good information about what their expenses will be during retirement,"
says Mitchell. "We know from our research at the Pension Research Council that there's a substantial
underestimation of the need for long-term care and nursing home insurance. People also don't understand
what medical costs may be in retirement. And many people don't focus enough on the risk posed by inflation.
We haven't had a lot of inflation lately, but even a low rate over 30 years of retirement can erode one's nest egg."
Perhaps the most neglected facet of retirement planning is longevity risk. "People tend not to think about mortality;
it's not a question people willingly face," according to Mitchell. "When people do think about mortality, at best they
think about life expectancy. But they may not understand that about half of all people live longer than their life expectancy.
Women especially can live into their 90s or even reach their 100th birthday."
Lack of Preparation
Any number of studies has shown that people are not properly prepared for retirement. In a May 2003 survey conducted
for MetLife, a major life insurance company, people aged 56 to 65 were asked a series of questions designed to test
their knowledge of retirement and income-planning statistics. On average, those surveyed answered only five of 15 questions correctly.
Among other things, a majority underestimated the life expectancy of a 65-year-old and did not think
that longevity was a significant risk in planning for retirement. When asked, "What is the greatest
financial risk facing retirees?" only 23% correctly answered longevity risk. Another question asked:
"An individual who reaches age 65 has a life expectancy of age 85. What are the chances he or she will
live beyond that age?" Only 37% gave the correct answer, which is 50%.
Another study – conducted by Watson Wyatt, a human resources consultancy, and reported in
the Aug. 23/24 issue of London's Financial Times – examined how the bear market in equities
over the last three years has affected people's retirement plans. The study, which included
4,500 United Kingdom residents aged 50 to 64, found that about one-quarter of respondents had
experienced losses of 25% to 50% in their stock portfolios, while about one-fifth had lost between
11% and 25%. Many of those surveyed said they have had no choice but to postpone retirement.
Survey results released Aug. 12 by Merrill Lynch show much the same thing. Only 47% of Americans
interviewed as part of Merrill's Retirement Preparedness Survey were either "somewhat confident" or
"very confident" that they will have saved enough once they retire. That was down from 90% in 1998,
a year when the bull market was still surging. Moreover, one-third said they believed that they will
not be able to retire at age 65 and only 20% said they were "very confident" in their overall investing ability.
In a prepared statement, Cynthia Hayes, a Merrill Lynch executive, said,
"We know that Americans have traditionally under-saved for retirement,
but these 2003 survey results serve as a wakeup call – for plan sponsors, individual investors and financial services providers."
Wharton's Mitchell points out that people with high incomes are not necessarily the best
retirement planners. "Research has shown that retirement-saving shortfalls run up and down the
income scale and wealth scale," Mitchell says. "In some cases, shortfalls were worst for people
with high earnings. Of course, these people are in a position to save a lot, but people
with high earnings also spend a lot. They don't necessarily set money aside."
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