Cover:Scare Tactics

Illustration By Red Nose Studio

Are many Americans in better shape with their retirement savings than they are being told? The standard income-replacement ratios against which participants are encouraged to gauge their retirement savings are "way off base," believes Scott Burns, a syndicated financial columnist and a Principal of investment management company AssetBuilder Inc. in Plano, Texas. "Many people are being told that they need to save more than they need for retirement."

In convincing many Americans that they must save more than they actually require, the financial services industry becomes "crazy-makers," as Burns calls its impact on participants who feel pressured to save at unrealistic levels. The traditional retirement-income modeling tools are nothing less than "financial malpractice," believes Laurence Kotlikoff, a Boston University Professor of Economics who also is President of Economic Security Planning, Inc., which has developed financial planning software aimed at calculating individuals' sustainable living standard as well as what they need to spend, save, and insure each year to maintain it. The industry's traditional savings goals drive people to put money into risky investments to reach the targets, he thinks.

Some question the usefulness of giving them ­conventional-wisdom targets in the first place. "There has been this holy grail of 70% to 80%," says Jack VanDerhei, Research Director at the Washington-based Employee Benefit Research Institute (EBRI). "Back in the days when people had a defined benefit plan and retiree health care, that probably made sense." However, American workers' situations vary so much today, he says, that those generalized targets do not apply as much.

However, arguing the fine points of replacement-ratio models does not accomplish much, believes Cecil Hemingway, Aon Consulting's U.S. Retirement Practice leader. "It is a silly debate," he says. The purpose of Aon's annual Replacement Ratio Study, for instance, "is to ask a very simple question: How much income do you need after retirement to reflect the standard of living that you had before retirement?" he says. "Because it tries to answer a general question, it is not going to apply to all individuals."

All replacement-ratio models have imperfections, Hemingway says. "The challenges in all the models are the unknowns," he says. "A big unknown is health care: We are kidding ourselves if we try to speculate on what health-care costs somebody will have in 20 years. We are dealing with such unknowables that tweaking models in an attempt to make them perfect is almost delusional, but it is helpful to know where general true north is."

During their working years, much of Americans' income goes toward raising and educating children, buying a house, and saving, Burns says. From the time someone gets married until his or her kids reach adulthood, he or she needs 5% to 6% real income growth per year to cover the cost of raising children, he says. Retirees—at least those who married and had children—see a major drop in expenses because of their reduced household size, Burns says. The children have moved out, and often the mortgage has been paid off. "There is this mountain you climb in the lifecycle, and none of that is taken into account by replacement ratios," he adds.