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You're Saving Enough for Retirement (Probably)Don't worry—you won't have to live on ramen and cat food.

By Tim Harford
Posted Saturday, June 14, 2008, at 8:01 AM ET
Are we saving enough for retirement?

Here's the conventional wisdom on pensions: You're a weak-willed and shortsighted fool who isn't saving enough, and as a result you will spend your retirement in poverty. The American press is loaded with hand-wringing on the subject—largely, although not exclusively, based on "research" from companies that sell pensions and investments. In Great Britain, the definitive statement was made by Adair Turner's Pension Commission in 2004: "Most people do not make rational decisions about long-term savings without encouragement and advice." Ouch.

The sense of impending doom has been deepened by the realization that both corporate pension plans and implicit pension promises from governments may have too little cash behind them. That may be true, but it is only indirectly relevant to the question of personal pension saving.

One of the results of this nervousness has been a search for ways to encourage people to save more: tax breaks and enrollment by default, for example.

But look more closely, and it is far from obvious that there is a serious and generalized problem with personal pension savings. It's hard to say for sure partly because the future is unknown and partly because it's difficult to determine exactly how much money should be in a sensibly funded pension. For example, if someone is making $100,000 a year, what pension income would count as sensible? $125,000 would probably be excessive—but what about medical and long-term care costs? $45,000 a year seems low, but many people get by happily on less.

Yet economists have been gamely making the effort; they look for "consumption smoothing" as a sign of sensible saving. In practice, that means that aiming to consume about as much after retirement as before. But even that simple comparison can be misleading. The economist Erik Hurst has recently calculated (PDF) that while most American households do cut back on spending after retiring, that does not literally mean tightening their belts: The cutbacks mean spending less on commuting and work clothes. Spending on food also falls, but the retirees eat just as well: They simply spend more of their plentiful leisure time cooking at home. Spending on entertainment and donations to charity increase. No sign there of a penurious dotage.

An admired analysis of retirement saving was published in 2006 in the Journal of Political Economy by John Karl Scholz and two colleagues (PDF). They concluded that more than 80 percent of Americans seemed to be on track to retire with enough money in the bank; the remainder were mostly not far short of sensible savings. Another economist, Laurence Kotlikoff, is famous for his calculations that the U.S. government has run up a staggering implicit debt in the form of Medicare and Social Security promises, but he seems sanguine about private saving. Kotlikoff believes that the savings plans that tend to be recommended by the "retirement calculators" on investment-company Web sites recommend saving too much and buying too much insurance. (Kotlikoff is now marketing his own retirement calculator.)

So should we be more relaxed about personal pensions? It's hard to be sure.

Some people do suffer impoverished retirements, but they tend to fall into two categories: those who were poor for most of their lives, anyway, and those who unexpectedly lost their jobs or their health in their 50s. In neither case is "more saving" the answer to the problem.

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Tim Harford is a columnist for the Financial Times. He is the author of The Undercover Economist, and his latest book is The Logic of Life.
Photograph of calculator by Joe Raedle/Newsmakers/Getty Images.
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Comments from the Fray

[Note: the post below produced a long interesting thread.]

The Social Security tax rate is 12.4%, so in a sense we're all saving a lot. The real question is what's being done with the money.

It's fun to consider an alternative universe in which your lifelong Social Security "contributions" go into stocks. Let's do a constant, 2008-dollar calculation. Let's assume you earn the median U.S. income of $48,000 throughout your life, and 12.4% goes into a personal retirement account that is invested in stocks, which are allowed to compound tax-free.

* For saving from ages 18 to 68, at a real rate of return of 8% per year, your age-68 retirement fund, in 2008 dollars, is $3,538,559.

* For saving from ages 22 to 65, at a more modest real rate of return of 6% per year, your age-65 retirement fund, in 2008 dollars, is $1,146,413.

People find these results too good to be true, but the math is incontrovertible. (Hope I didn't blow it! Check it yourself.). The result depends on your assumptions, but it's pretty good for all realistic assumptions. Which would you rather have on retirement:

(a) a fund that's in the $millions, or
(b) Social Security?

It's tragic that your SocSec money, which is taken away from you, is not put into proper investments. Moreover, the enhanced level of investment resulting from the stock approach would promote economic growth. The money could be invested worldwide in index funds to insulate against the demographic demons that plague Social Security…

--Martin Straub

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(6/15)

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