Makin' Money

GAO to future retirees: Forget the Golden Years

Chris Farrell Jul 5, 2011

Comedian George Burns used to get a laugh saying, “Don’t stay in bed, unless you can make money in bed.” Well, for too many future retirees it isn’t a joke.

The U.S. Government Accountability Office recently chimed in with it own version of the retirement-will-be-tough going forward story. In Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices, the federal agency notes that the risk of outliving assets is all too real. For instance, a husband and wife who are both 65 years old have about a 47 percent chance that at least one of them will live until 90.

With the bitter bipartisan divide in Washington little to nothing will be done to offer ordinary Americans greater financial security in their old age. There is the possibility that old age will become increasingly perilous with cuts in Social Security, Medicaid and Medicare.

The 79 page report is thorough, sober, and not easy to read. The authors went through the main retirement planning literature and interviewed experts. Boiling down the advice, it’s take Social Security as late as possible and work as long as possible. Middle income retirees should put some of their 401(k)-type money into an immediate annuity to guarantee another source of lifetime income. Lower wage workers need to save more.

Among the reports highlights is just how much an older generation has gotten the message to work longer.

It’s a remarkable transformation. In the mid-1980s a hundred year long trend toward an ever lower retirement age reversed itself.

Another point to emphasize: The retirement withdrawal calculations from 401(k)-type plans are incredibly complicated, involving all kinds of known unknowns, such as how long you’ll live, inflation rates, interest rates and the like. And even if you’ve done everything right there is always the luck of timing. For example, the sequence of investment returns and withdrawals from a 401(k) matter.

Let’s say you retire, and the annual investment returns on retirement savings are up 7 percent in the first year, then down 13 percent in the following year, and then up 27 percent. The returns over the following years repeat that pattern, over and over again. The average annual return on the portfolio is 7 percent.

Now, reverse the sequence of returns in the second and third year. Everything else remains the same. The average annual return remains 7 percent. But here’s the kicker: Savings would be depleted sooner with the first sequence of returns–18 years vs. 24 years.

The GAO calls for improvements in the annuity market to make it easier and cheaper for retirees to annuitize some of their income. There is movement in this area–definitely a good sign. Bloomberg has a good review of the report here.

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