Stern Advice: What All Those Retirement Studies Get Wrong

Another day, another academic study about how retirees should draw down their savings to make sure they last a lifetime.

Because of the explosive growth of privately owned plans like 401(k)s and individual retirement accounts, the study of retirement savings draw-down has exploded in recent years, the Society of Actuaries has observed. And yet, when that group reviewed more than 100 papers on the subject recently, it found the same problems with study after study.

There is a significant gap between the behavior implied by economic models and those of real-life individuals, the actuaries concluded. The team of researchers, led by Bonnie-Jeanne MacDonald, identified three significant conceptual/methodological weaknesses in the relatively recent surge of academic research on this topic.

Put simply, the studies leave out too much: They tend not to include the effect of taxes on withdrawals, or the responsiveness of withdrawals to personal circumstances like unemployment or health problems. And they don't do a very good job of predicting the way real retirees handle their money.

Here are some of the key omissions and what they may mean for your retirement fund.

-- Retirees are more conservative than they are given credit for. Much of the research about the draw-down period focuses on the risk that retirees will use up their funds too fast and run out of money. But in fact, the few studies of real retiree behavior show people spending down their retirement plans very slowly.

Those in the top income quintile actually accumulated wealth, the study finds. The concern that seniors will spend their savings too quickly stands in contrast to the frequent findings that retirees are slow in spending down their savings.

For example, retirement fund powerhouse T. Rowe Price generally tells new retirees that they can withdraw 4 percent of their retirement account assets in their first year of retirement, and then increase that withdrawal amount by 3 percent a year to cover inflation. But it finds that many of its fund investors do not even increase their withdrawal amount every year.

-- Retirees don't want annuities. The insurance industry and some independent experts have suggested that by annuitizing -- trading in a lump sum for a guaranteed monthly payment for life -- retirees could protect themselves from running out of money. But individual investors have historically been unwilling to hop on those products.

There is a high degree of aversion to voluntary annuitization among retirees, the actuaries' study found. This aversion stemmed from distrust of financial institutions and a dislike for the loss of control over financial assets.

Lately, they have been emphasizing the idea of partial retirement -- that retirees could put a small percentage of their money to work in an annuity. More broadly, the financial services industry has been developing some annuity-like products that, while lacking insurance-like guarantees, would offer monthly annuity-like payments and the flexibility for savers to withdraw funds in larger amounts when they need them.

-- Health is a big, and under-addressed, factor. Most draw-down strategies focus on the effect of investment performance on retirement account balances. But a draw-down strategy that links to health (for example by recalculating withdrawals every year based on longevity expectations) could prove more valuable. the study said. Furthermore, health issues also prevent some people from working as long as they would like and sometimes require retirees to take larger sums out of their savings during a crisis, so making retirement spending plans without factoring in health seems of limited value.

-- Taxes are a big factor too. Nearly all previously published studies have ignored the potentially significant impact of government taxes and transfers when quantitatively evaluating different draw-down strategies, the report said. The tax question would affect retirees in myriad ways. Tax-deferred retirement plans, such as 401(k) accounts, require retirees to pay income taxes on all of the money they take out. That might prompt some of them to adjust voluntary withdrawals in response to their annual tax rates. Retirees may also be unwilling to lock up all of their money in tax-deferred products because they may find regular investments, currently subject to comparatively low capital gains and dividend tax rates, could be more efficient.

-- There's no substitute for a personal analysis. While the actuaries concluded that academics and industry analysts should broaden their studies, it really behooves every would-be retiree to look at their own situation in all of its specifics. Personal earnings ability, other sources of income, investment risk tolerance, home equity, tax rate, life expectancy and the desire to leave a bequest are just some of the factors that might go into that how much can I withdraw decision. It probably makes sense to call in a really good numbers person, like a retirement-savvy accountant or even... an actuary.