December 13, 2022
Increasing Savings for Retirement
Saving for retirement involves
sacrificing something of value today in exchange for something
of value in the future. Economists have long argued that this
decision is biased in favor of current values because they are
more certain than future values, and also closer at hand. The
consequence is insufficient savings in the earlier stages of
life, resulting in impoverishment later in life.
The mandatory savings plan administered
by Social Security is an important offset but it doesn’t cut
very deep, and it might depress voluntary private savings by
providing a rationale for ignoring it. What is needed are
programs to encourage private savings. The deficiency is not an
absence of savings instruments, there are plenty of those, what
is lacking is the incentive to use those instruments to save for
retirement.
The Incentive to Save
People are motivated to save when:
-
Anticipated future benefits are known.
-
Costs of realizing those benefits are known
-
The wait period until benefits occur is short and known.
The conditions encouraging saving also
exist when consumers plan for a specific event at a known time,
such as a family wedding or a round-the-world trip. Contrast
this with saving for retirement. The closest most consumers come
to describing the benefit is “maintaining their life style.”
Even if that objective was definable with precision, few have a
clue regarding how much they must save during their earning
years to realize it. And of course, they could die before they
get there. It is not surprising that savings for retirement gets
short-changed.
Increasing the Incentive to Save
For Retirement
My experience with the extra payment
calculator raised a question in my mind as to whether it was
possible to develop a similar tool, meeting the requirements
specified above, that would encourage consumers to increase
their total savings for retirement? The answer has turned out to
be “yes”, my colleague Allan Redstone and I have designed such a
tool. We call it the Retirement Saver (RS). It builds on an
earlier program called Retirement Funds Integrator (RFI) that
integrates financial asset management, reverse mortgages and
annuities.
The bottom-line output of RFI is the
monthly spendable funds available to the retiree from all
sources through the retirement period, plus the estate value at
any point in the process. RS shows how any savings plan designed
by the retiree before retirement affects those outputs.
Spendable funds are a wonderful proxy for retirement benefits
because they will support any activity the retiree wants to
pursue when the time comes.
Illustration: A Savings Plan For
a Non-Affluent Homeowner
The table below is drawn from our new
RS. The illustration is for a male of 40 who has $100,000 of
financial assets, a house worth $400,000 with a $200,000
mortgage balance who adopts a saving plan of $500 a month,
rising by 2% a year. The table shows how his initial monthly
spendable funds is affected by his saving plan, and by the
addition of a HECM reverse mortgage.
The note to the table shows the wide
range of assumptions that are involved in the calculation. It
was calculated using our new Retirement Savings Calculator,
which is now on my three web sites (see below). The calculator
allows anyone to develop a retirement plan that is based on the
features and assumptions that are applicable to them.
Estate Value Displayed
Graphically
The table shown above has two
limitations. First, it shows the initial spendable funds amount
at retirement, but not the changes that occur in later years.
Second, it does not show the retiree’s estate value. Both are
displayed in the time series chart shown below covering the same
retiree features.
The chart shows how the savings plan and
the reverse mortgage contribute to the growth of spendable funds
over time, and how the estate value is affected by these
choices. The savings plan actually increases estate value in the
early years but the reverse mortgage has the opposite effect.
Whether this affects a decision on whether or not to include a
reverse mortgage in the plan depends on the consumer’s attitude
toward estate value.
Managing the Plan Over Time
A retirement plan is almost surely going
to be affected by changes in financial asset returns, interest
rates and other developments during the period between the age
at which a savings plan is adopted and the expected age at
retirement. Using the plan successfully requires that the plan
be updated periodically, perhaps once a year or whenever the
financial landscape undergoes a significant change.
How to Begin the Process
Since a retirement savings plan involves
looking ahead for several decades, the plan should be based on
the best guess of how the consumer’s finances will evolve over
that period. As those assumed conditions change, the savings
routine can be adjusted as needed and a new retirement plan will
emerge.
The mistake to be avoided is to delay
beginning the process until conditions are more favorable. There
are always reasons to delay, today it might be the incipient
inflation and/or fear of an impending recession. If necessary,
the consumer can begin a savings plan in which savings are
nominal or even zero for some period before they become
positive. The key is to begin.
Home Equity Growth as a Savings
Component
Consumers who have a significant portion
of their wealth in their home should aim to supplement their
periodic savings by increasing their home equity during the
period before retirement. Unless the consumer wants to leave the
home equity in her estate, that equity can be converted into a
reverse mortgage credit line to supplement spendable funds
during retirement, as illustrated in the table and the chart.
While the home equity on which reverse mortgages are based is
impacted by general market trends over which individual retirees
have no control, owners have discretion over maintenance and
improvements that affect the value of their own particular
house.
The key to making the reverse mortgage
an effective component of a retirement plan is to phase
systematic draws on the credit line into the plan, which is
exactly what the example shown above has done. Homeowners who
draw the maximum amount available from their reverse mortgage at
the first opportunity sabotage their retirement.
Calculator Availability and
Usage
The Retirement Saving calculator is
available to anyone at:
In addition, in order to accelerate the
savings process, I have decided to make it available to any
financial intermediary that would like to offer it to their
clients. There would be no charge for installation, and updates
based on changes in annuity and reverse mortgage prices will
also be free.
Third parties who accept this offer, whether they are web-based lead generators, depositories or advisory firms, will probably find it useful to maintain updated versions of each client’s account projected forward. Depositories in particular could make this a feature of their IRA accounts, where the account-holder can monitor how their rising account balance impacts their retirement funds. This will solidify the depository’s relationship with the client, and position themself to advise on the conversion of a projected retirement plan into an actual plan when the time comes.
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