Recalibrating Retirement Spending and Saving (Pensions Research Council) [Hardcover]

Recalibrating Retirement Spending and Saving. John Ameriks and Olivia S. Mitchell, eds. Oxford University Press, 2008, ISBN 978-0-199-54910-8, 320 pages. doi:10.1017/S1474747209004077
Two leading researchers, John Ameriks and Olivia S. Mitchell, have organized and contributed to a highly informative and thought provoking book aimed at enhancing retiree financial decision making and security. It provides new analyses that helps us better understand the behavior of the retired population and a number of practical ideas. All the articles are uniformly good, and I comment only on a selected few.
2 Book reviews
The first section of the book covers key issues affecting retirement security. Sewin Chan and Ann Huff Stevens analyze the HRS to measure the extent of ``retirement reversal, '' and they find that about one in three older people move from a more retired to less retired state at some point. Combine that with the tendency to a variegated path to retirement, rather than retirement at once, highlights the need to re-conceptualize what retirement means. Erik Hurst conducts a careful analysis of several datasets to evaluate declines in consumption after retirement. He demonstrates that most types of spending stay the same or increase, but work-related consumption, such as for clothing, transportation, and expenditures for food, do decline. Less spending for clothing and transportation are easy to understand, food expenditures are more complex. But Hurst shows that, in most cases, retirees do not suffer a decline in the quality of food; rather better shopping habits and increased home production are mainly responsible. About one-fifth of the retired population does suffer a decline in food expenditures caused by economic want, and many of those experienced a health shock and retired involuntarily. This leads Hurst to the interesting suggestion that insurance products be developed to protect people's consumption when they suffer a health shock.
The second section addresses the impact of tax policy on Individual Retirement Account (IRA) withdrawals, bequests, and the ideal timing of Social Security claiming. Sarah Holden and Brian Reid offer an excellent analysis of withdrawals from IRAs. They show that individuals tend to hold onto IRAs as long as possible, and Required Minimum Distributions (RMDs) are the main reason for withdrawals. To some extent, this indicates that tax policy has worked to keep these accumulations for retirement and old age, and to some extent it indicates a desire to maintain principal. James Mahaney and Peter Carlson contributed an excellent article on the ideal time to claim Social Security. They show that, for most primary earners, claiming benefits as late as possible is beneficial. Today, most workers do not do that so more effective claiming strategies can importantly strengthen financial security.
The third section brings forward a number of new ideas for financial strategies and products that promise to help retirees manage their assets more efficiently. William Sharpe, Jason Scott, and John Watson demonstrate convincingly that two financial strategies frequently recommended by financial advisors are sub-optimal. Specifically, it is inefficient to move assets from equities to fixed investments, when not accompanied by advice on how to adjust spending to market conditions. For example, it can be dangerous to propose the typical ``4% rule, '' which advises that a retiree should start withdrawing this fraction of assets and then adjust upward by inflation, particularly when accompanied with advice to keep a substantial asset allocation in equities. The authors propose a better rule than one tied to investments.
Several articles deal with annuitization and health. Cassio Turra and Olivia Mitchell use modeling, supplemented by an analysis of HRS data to indicate that health conditions and anticipated out-of-pocket health care expenses often make life annuities sub-optimal with current life annuity pricing, which assumes anti-selection. The authors conclude that life annuities that provide higher payouts when there is a medical shock would make the product more attractive to many. John Ameriks, Andrew Caplan, Steven Laufer and Stijn Van Nieuweburgh examine the impact of Medicaid aversion and the bequest motive on receptivity to annuitize. Medicaid aversion is the level of undesirability of depending upon Medicaid to pay for long term care costs. They find that people who desire to leave an estate and the Medicaid-averse desire to have cash, making life annuities less attractive due to their lesser liquidity. This leads the authors to suggest annuity structures that provide additional funds if the need arises for long term care. They model the higher level of interest for these products among the segment who have no bequest motive and are Medicaid-averse (the best target market for this product). Finally, David Brazell, Jason Brown and Mark Warshwsky discuss a combination life annuity and long term care insurance approach, one granted tax benefits under the 2009 Pension Protection Act. Combining insurance protection against long term care costs with a life annuity is believed to reduce anti-selection, reduce the cost of long term care insurance, and help extend protection against covered risks.
Book reviews 3
One of the book's important contributions is its deeper understanding of the retired population's heterogeneity and the need for specific solutions for key segments, particularly since many retirees are not in excellent health. Overall, the articles cover important topics and are well researched, and it offers a welcome mix of authors, both academics and practitioners. The volume will be of interest to a broad range of people, providing academics with new insights and suggestions for research questions, policymakers with suggestions for enhancing retirement security, private market product designers with new ideas for insurance products and insights on target markets, and financial advisors who will find a critique of some commonly used financial strategies.
MATHEW GREENWALD
Mathew Greenwald & Associates, Inc.