The biggest unanswered question about retiring in America

September 10, 2013

America has moved to a system where nearly everyone is expected to save and invest for their retirement. Yet remarkably little attention has been paid to the big question: what should people do with their money when they actually retire? Neither the government nor the financial industry has any good answers. This leaves individuals ill-equipped to figure it out for themselves. Before the bulk of baby boomers reach retirement they will need a better solution. That will require the government and the financial industry to define their role in how people finance their retirement.

Starting in the 1980s many countries (America, Chile and later Australia, Britain, Sweden, Switzerland, Singapore and other Latin American and Nordic countries) moved to a regime where individuals had to save and invest to finance their retirement. Prior to this, pensions from the government or employers provided stable, predictable, and often inflation-adjusted income. As the typical retirement lengthened and populations aged, the old way looked unsustainable. Personal accounts, which shift the burden to individuals, became more popular. The individual account solution has well-known problems associated with the saving stage: people don’t save enough, pay too much for investment funds, and do not understand investment risk they are exposed to, as the recent economic crisis revealed. As these programs evolved, so have solutions and better regulation. Countries like Australia, Switzerland and Chile require people to save a large fraction of their income. Sensible and reasonably priced default investment options and savings rates help people make better decisions. Some countries, like Switzerland, provide a minimum return on the accounts’ assets. But even with best practices for the saving phase, major questions remain: When people arrive at retirement, what are they supposed to do with their life savings? How much can they spend each year and how should they invest their assets?

Those questions don’t have easy answers. If you over-spend you might run out of money. If you spend too little you needlessly scrimp. The cost of investment risk is bigger post-retirement because you don’t have years of future returns and income ahead of you. It’s further complicated by uncertainty. Most people don’t know how long they and their spouse will live. Aging diminishes ability to manage money and increases vulnerability to fraud. Research by economists James Poterba, Steven Venti and David Wise found many American retirees barely spend their wealth beyond what’s required. But they liquidate their assets, often selling their home, once they or their spouse has a significant health event and dies. Many people die with almost no assets left over.

Economists have traditionally suggested that people buy an inflation-indexed annuity that makes payments for life. An annuity is a contract, typically with an insurance company, in which you pay a premium and the insurer pays you, at regular intervals, for a specified period or your lifetime. The payments might be linked to investment performance, inflation, or a fixed nominal amount. A real, fixed life-annuity ensures you won’t outlive your assets and will get predictable income, just like the defined benefit pension or state benefits do. But that comes at a cost of no liquidity or option to leave money to your heirs if you die early. The liquidity issue is significant in America where healthcare expenses aren’t entirely covered by Medicare. The Employee Benefit Research Institute estimates that an American couple will need at least $227,000 in order to be certain they’ll be able to pay for their post-retirement health expenses. There’s wide variability around that estimate and it doesn’t even include long-term care. Retirement only ends one way and death tends to be an expensive event. It’s understandable that people are reluctant to turn over their life savings to an insurance company, but that leaves them vulnerable to investment risk and over or under-spending.

Currently in America the only post-retirement requirement is you must withdraw a minimum percent, based on age and marital status, of your retirement account each year. But this rule was not intended to be an optimal drawdown strategy; it was meant to ensure people paid taxes on their tax-deferred retirement accounts. Simple rule-of-thumb strategies, like spending 4 percent of your assets, have proven inadequate and don’t address investment risk.

Instead, the government should encourage people to annuitize at least some of the money in their retirement accounts with an insurance company. That might mean favorable tax treatment, or requiring people to buy an annuity. We have polices to encourage retirement saving in order to overcome behavioral biases, myopia or financial illiteracy that lead to bad decisions. Retirement spending and investing requires the same guidance and standards.

Similar issues exist abroad. Australia and Switzerland force their citizens to save a large share of their income, but then don’t provide many requirements about spending down the money. Culture, history and some light tax incentives play an important role. In Australia, more than 70 percent of non-public employees take large lump-sum withdrawals from their retirement accounts. They spend some of it and manage their drawdowns themselves. If Australian retirees run out of money they can claim a means-tested state pension, which most Australians live on. Switzerland experienced the opposite result; more than 80 percent of Swiss retirees annuitize their pension accounts.

Other countries offer more structure. Britain used to require people to buy an annuity by age 75. But this proved unpopular, especially in the current low interest rate environment where annuities are very expensive. After 2011 the requirement became less demanding. Now Britons must receive a minimum amount of guaranteed income from some source: annuity, defined benefit or state plan. Chile requires retirees to choose between two spend-down options. They can either make regular withdrawals based on a government-provided formula and their account balance. Or they may buy an annuity, assuming the annuity value is larger than a defined amount. Most Chileans opt for the annuity. Chile has one of the world’s more competitive and well-functioning annuity markets.

Whether or not the government does more to favor annuities, the retirement income question also requires solutions from industry. The annuity market has a bad reputation in America because of confusing terms; high, opaque fees; and large surrender costs. Annuity prices also vary with interest rates. This exposes retirees to another source of risk when they buy an annuity. Not surprisingly, few Americans buy income annuities. That may change as more people retire with a 401(k) and need lifetime income. A feasible product offering guaranteed income and liquidity that people will buy has become the Holy Grail in the industry. So far there aren’t any good solutions that the market has embraced.

If the government relies on the market to provide income for many of its citizens, it must regulate the annuity market. If a large insurer goes out of business and can’t pay retirees’ income, will the Federal government step in to make payments, similar to deposit insurance? There’s also scope for regulation to ensure that annuity terms and pricing are transparent and competitive. A better annuity market will require more transparency, competition and wider participation. Thoughtful regulation can ease public distrust of annuities.

The world’s most sophisticated economies moved to individual accounts to finance retirement, but that’s an incomplete solution. So far the half-solution hasn’t been a problem, because few have retired with them, yet, as their primary source of income. But as more baby boomers reach retirement that will change and we’ll need better answers, preferably before they get there.

PHOTO: Donald Smitherman, 98, kisses his wife Marlene at the end of a dance in Sun City, Arizona, January 5, 2013. REUTERS/Lucy Nicholson 



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Excellent article! Please run for congress and continue this discussion there were it counts!

Posted by tmc | Report as abusive

you wrote, “Neither the government nor the financial industry has any good answers”. You’re kidding, right? The core business for any financial planner/financial adviser are clients already in retirement. You want simple “one size fits all” answers? There aren’t any. If it were that simple, nobody would NEED financial advice in retirement. You should have talked to a couple of financial industry professionals before writing this fertilizer (just my humble opinion). Send your retired Grandparents to me. We’ll discuss their situation, their goals, their particular financial risks and their risk tolerance. I’ll give them direct advice that is tailored to fit their needs.

Posted by Hairry | Report as abusive

… why on earth would we want the Federal government to take more control of our personal finances? You know, this notion could be stretched further. The primary reason many Americans are not well funded for retirement is because they live above their means. Yes, lets urge Congress to take action. The government should issue each person a “license to spend”, and require retailers, car dealers, restaurants … to sell only to those who have government authority to spend that money. We’ll have to create a new Federal agency to establish and enforce regulations. More taxes to fund the program.

Posted by Hairry | Report as abusive

Because @Hairry, the vast majority of people don’t have “personnel finances” and definitely can’t afford to talk to someone like YOU. You would laugh at them for only have an income of 30-40k and not being able to save anything as the banksters fee all ends of every transaction and offer .0001% interest to them.

Posted by tmc | Report as abusive

TMC, thank you for your reply. So for the people you’ve described, “income of 30-40k” and with no savings, we already have programs, Social Security and welfare. In this article, Ms Schrager proposes “the government should encourage people to annuitize at least some of the money in their retirement accounts with an insurance company. That might mean favorable tax treatment, or requiring people to buy an annuity.” Ms Schrager is clearly referring to the people who DO gave savings. She is also clearly suggesting that the Federal Government step in with yet more regulation as to how we should manage our savings. I have, on occasion, been contacted by the person you’ve described (low income, no money). I talk to them about budgeting and about how they might qualify for a job with higher earnings. Some of them feel less hopeless after our conversation and are able to follow my advice. I have never laughed at anyone who has asked for my help. I have to add that I think it is amusing that Ms Schrager points to “favorable tax treatment” as an advantage of an annuity. Most of our population- the average person- is unable to fully fund the tax deferred accounts already available to them (401k’s, 403b’s IRA’s, SEP IRA’s, Simple IRA’s) and, most of my truly affluent clients choose to not load up on annuities because the money they later draw from an annuity will be taxed as ordinary incomee (do to LIFO tax treatment). This is useful dialogue for many people tmc, thank you for your comments.

Posted by Hairry | Report as abusive

if companies or governments can’t afford retirement, how in the world can individuals do it? especially since pensions were managed full time by professionals. while individual savings are done part time, by amateurs. and considering that some seem to want to cancel Medicare, with some thing works much worse. and knowing that unless you live right or are extremely lucky (either in your DNA, or dont get hit by some disaster. which means even if you could save millions, you might out live your income

Posted by willid3 | Report as abusive

Not going to work @Hairry, nice try though. In fact the article is talking about the vast majority of people. Those other governments she describes have policies that intended to help all of their people, not just the affluent. The American financial system was working for many people, perhaps from 75k and up, when the shifts she mentions started taking place. It was quite easy to predict that once the 401k became popular, it would be the only real tool available. Once that occurred, again only to easy to predict that matches would disappear (as they have) and fees would sky rocket, as they have. Now as you say most people are unable to even fund what is left to us. Unless the financial system gets a real overhaul soon, even those semi-affluent 500k and up types will find their money became a target of wall street and they will have little left for retirement. The longer this goes on, the worse it gets, just like playing a game of monopoly.
So again we do not need more people like you to interpret the complexities that you heap upon us, we need far more simple approaches so we can see the con-artist for what they are. I’m not a real fan of government and find ours quite inept at most things, but at least they have good intentions. The financial industry does not. It is intent on making my money their money. So yes we need more government regulation and control of the financial system and soon, and far less “financial industry professionals”. In fact “nobody would NEED financial advice in retirement” is a great goal!
This article and the authors suggestions are not fertilizer, they are what the vast majority of this country needs and wants.

Posted by tmc | Report as abusive

“Economists have traditionally suggested that people buy an inflation-indexed annuity that makes payments for life.”

It has always struck me that inflation is the “tax” governments put on their citizens in the form of ever-present institutionalized theft of purchasing power. Maybe I’m a radical,, but isn’t it a duty of government to PROTECT the purchasing power of it’s currency? But no, today governments WANT a certain “magic” level of inflation…a rate that does not make the masses light the torches and start boiling the oil.

We have ceased to be “We, the people” and become “We, the meek and easily led down the garden path”. John Kerry says Americans have the right to be stupid, but there are obviously some things we CAN do that we shouldn’t!

Posted by OneOfTheSheep | Report as abusive

( I blame our education sysytem )

Posted by Hairry | Report as abusive


“I’m not a real fan of government and find ours quite inept at most things, but at least they have good intentions.”

What are you aware of that the rest of us are not in reaching this incredibly generous conclusion? Our government and it’s bureaucrats are the inherent enemy of every tax paying citizen, upon whom it lawfully preys!

Posted by OneOfTheSheep | Report as abusive

Well Sheepster, It’s because I have less faith in Corporate America running the show, as it pretty much is now. All peoples need a government. Instead of just chastising and berating ours (playing into the corporate hands) we should be trying to take it back and improve it. In one breath we say we’re the greatest country in the world because of it, then in the next rail against it as if it were the enemy. If our government is truly your enemy, then please leave peacefully. If you wish our government were better, suggest solutions. The best and only real place to start…
1. Term limits for congress and SCOTUS
2. Campaign finance reform

Posted by tmc | Report as abusive


OK, I’m with you on your two. But I’d also like to see government actually protect instead of erode the value of the dollar. I’d like to see antitrust actions against cell phone companies who use their “limited choice” reality to demand that customers give up their right to a jury in disputes, banks too. I’d like to see usury laws back in place and enforced. I’d like judges to again be accountable for damages they are responsible for when acting in bad faith, or out of ignorance, prejudice, undue influence or anger. I’d like to see it again mandatory that they “follow the law” instead of making it. I’d like to see citizen access to the small claims courts they pay for against federal,, state and local government overreach, particularly when it comes to property tax disputes. And I’d like to see a federal ombudsman with real teeth one could seek assistance from when states refuse to apply their own laws equally to their citizens.

Posted by OneOfTheSheep | Report as abusive

The number that shocked me was the amount of money needed to have health care in America during retirement – more than a quarter of a million dollars !!! And that is apparently above and beyond Medicare. Absolutely frightening.

Posted by euro-yank | Report as abusive

First, I see no mention of debt in the article or the comments. As a 57 year old retiree who is completely debt free I can tell you from my personal experience that without debt you can live a nice middle class life on $50 to $70,000 per year. DEBT is the #1 retirement killer, it’s the equivalent of trying to swim with an anchor tied to you.

Second, when you buy an annuity you are placing your trust in the insurance company who issues same that they will be able to pay. Just the other day I read an article that explained why New York State superintendent of financial services Benjamin Lawsky has pulled New York out of a 50 state agreement that changed accounting rules and enabled life insurers to effectively “police themselves”. Lawsky found that a sample of 16 insurers claiming to have increased loss reserves by $10 billion had actually only added $668 million to reserves.

Be careful…..remember, there is no FDIC for life insurers. When you buy an annuity you are putting your money and trust in the insurer. Of course in today’s world if your annuity issuer were to become insolvent Uncle Sam would somehow ride to the rescue. Or would he?

Posted by Missinginaction | Report as abusive

Debt and cost of healthcare in our retirement years are the major reasons we struggle in retirement. Most of the individuals I work with(100K-200K salaries)age 50-60 don’t save enough, used their home equity as a way to vacation or buy nice cars in past years and still have not recouped the money years later. They want what those that can truly afford have, fancy cars, multiple expensive vacations, expensive meals out regularly Etc.. The Corporations and Banking system are doing a wonderful job at selling us the idea that we can all live like those Rich Guys. I also see in doing so most are in poor health as having fun in life is more important then living a good healthy life. I on the other hand at 55 yrs. do as my parents did, go on one decent but not extravagant vacation, refuse to buy the latest cell phone and plan, do my own yard work which I call productive relaxation, my house almost paid off(Home business went Bad) it would have been paid off 8 years ago.. The last 10 years of employment, if all goes right and we can deal with health issues, should go to heavier savings.
That still leaves the need for a plan for my cash in retirement…. still not sure since I also see it as too much unearned freebies to the insurance companies just to pay me back what I have earned. The wolves are guarding the hen house in our Banking, Insurance and the whole financial system. And those wolves are also our elected officials.
What was wrong with the image of Ward Cleaver( a college educated upper middle income business man) cutting his own grass…. Kind of off base but relevant in how we perceive ourselves in our ability to do what we need into retirement.

Posted by MJB58 | Report as abusive

I have built up a good retirement plan and it does not depend on the government for anything, except paying me what SS I have coming. I also don’t trust Wall Street, an insurance company, or a financial planner to have my best interests in their plan, they all want to make money off of me. My plan is built around multiple sources of income (SS, Bond funds, stock funds, REIT funds, individual stocks and several businesses I own, which can operate with nominal input from me) and if one, or more underperform I will have the others to compensate. I trust myself and I will not put my trust in the government, I just want the government to pay me what they owe me and otherwise stay the heck out of my life.

Posted by texasop31 | Report as abusive