Investors must think more critically about income replacement in retirement and when to take benefits, says Professor Shlomo Benartzi, chief behavioral economist at Allianz.
Christine Benz: I would like to shift gears and talk about people who are in the decumulation phase of retirement, so people who are getting set to retire, maybe already retired. It's been a very challenging environment. You've got lower interest rates, extra high volatility in the equity markets, as well as the fact that a lot of retirees and pre-retirees just haven't saved what they need to.
I'm wondering if you can discuss some of the key behavioral mistakes that this contingent of people is making and also some ideas for helping overcome them?
Shlomo Benartzi: Sure. I think we have to start thinking first about the 401(k) environment right now, and I love the analogy that Professor David Blake from the U.K. came up with, which is an airplane as opposed to a 401(k) plan.
Think about it: Automatically enrolling people in a 401(k) plan is kind of getting to your seat in the plane, putting your seat belt on, and somehow the plane automatically takes off. You don't have to do anything. So, think about it as auto-takeoff.
Then think about increasing your saving rate automatically, like the Save More Tomorrow program. It's some automatic climb that the auto pilot actually takes care of to go to 40,000 feet cruising altitude.
And think about target-date funds or some portfolio solutions, one-stop portfolio solutions for people as the autopilot cruising between Los Angeles and Tokyo, going round the storms and safely getting to Japan. Now, it's the decumulation phase. People have to figure out how to use their money.
Benz: Or fly the plane in this case, right?
Benartzi: They have to figure out how to land, but there is no landing gear. Our 401(k) system now is like an airplane that is missing the landing gear. We do not have retirement income solutions incorporated in 401(k) plans. So, we virtually tell people at the point of retirement go and figure it out on your own. And it wouldn't be surprising that most people struggle and make mistakes.
Benz: One area where we have seen research is in the realm of annuities. So, there is some resistance among new retirees to consider annuities even though there's a lot of research pointing to annuities being a pretty effective means of getting some income out of your portfolio in retirement. What is driving that behavioral aversion to annuities and is there any research that points to how to help retirees with that?
Benartzi: I think there are a couple of issues here. One is the annuities and how people should invest their money when they retire. And Richard Thaler, Alessandro Previtero, and I just came with a paper we call "Annuity Puzzles" that is really around this issue. Lifetime income at retirement makes a lot of sense. Annuities are well positioned to provide it, but people don't buy it, so that's a big issue.
But I think we have to think first about the big picture, and I think we miss a lot of opportunities to use behavioral finance and help people at the point of retirement by mainly focusing just on the investing side. People have to first of all think what lifestyle they would like to have at retirement. There is some evidence that the 70% rule of thumb, you should be planning to spend 70% at retirement…
Benz: Or 80% in some cases.
Benartzi: …or 80%, relative to what you spend before is misleading and insufficient. Think of the 70% really as a 30% rule, and think what you are going to cut. As soon as you think about it, you frame the issue as cutting my spending by 30% and having to come up with specific, vivid examples of items you are going to stop consuming. People immediately kind of go back and say, no, I should have 100% not 70%.
Benz: They are not saving for retirement anymore, that's a piece, right?
Benartzi: It's a huge piece, but they have to think about the lifestyle, but they have to think about also when to retire, because they might have not saved enough, and when to claim social security benefits. A lot of people claim it as soon as they can at age 62. If they wait a few years, they can double the social security payments.
So, when to retire, when to start claiming benefits, how much to spend every month so I don't run out of money, and then of course, how to invest the funds? It's these portfolio of decisions that people should really think about.
The data shows that over the last five or six decades, people save less, people retire earlier, and people live longer. That's not going to work. If you think about it very naively, take a lifespan and think about it, a third of it we are either kids or getting education or getting ready to work, a third of it we work, and a third of it will be in retirement. We are only working a third of our lifespan. We cannot sponsor our retirement like that.
Benz: Right. Right. Well, thank you so much for sharing your insights. We very much appreciate you being here.
Benartzi: Thank you.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
