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The unrealistic expectations of retirement behaviour

Many people believe they have a plan for retirement – but there is a big gap between expectation and reality.

How much do I need for retirement?

For many, it’s a question that ranks far down the list of more urgent priorities, like buying groceries, paying rent or student loans. But chances are, it’s more than you’d think – due to a number of reasons that reveal how our expectations of our later years don’t match up with the realities of living on a fixed income.

Outsize expectations

Take the US, for example.

Fewer than half of American baby boomers have more than $100,000 in retirement funds, even though one estimate puts healthcare costs in retirement for the average couple at $280,000. One Merrill Lynch report suggests that one in five Americans don’t know how much money they’ll need in retirement and that most under-save by nearly 20%.

Another report reflects the confusion. Almost two-thirds of US baby boomers are confident they can retire with a comfortable lifestyle, even though just over a third believe they’re saving enough money. Nearly half of all respondents believe their standard of living will stay the same.

The numbers tell a different story, however, and a series of misconceptions may be to blame.

‘If only I’d known’

One reason we do not save enough for retirement may be related to incorrect perceptions around earning power as we get older. In the US, women tend to hit their peak earnings potential by 39, while men’s salaries continue to climb into their late 40s.

Although small salary increases are likely in later years, the pace of inflation coupled with lifestyle creep (when additional income leads to increasingly expensive lifestyle choices) tend to cancel out this modest earnings growth.

The accepted rule of thumb is to save 15% of your yearly salary for retirement. Yet half of all Americans save much less than this. Some save nothing at all.

Putting off saving for retirement until later in life – even in higher amounts – rarely outperforms earlier savings with compounding interest

Putting off saving for retirement until later in life – even in higher amounts – rarely outperforms earlier savings with compounding interest. According to a survey from American financial services company Northwestern Mutual, one in three baby boomers has $25,000 or less saved.

Other countries save more – but still can run into unforeseen problems.

For instance, Germans tend to be more conscientious savers, paying into a state scheme whereby working-age citizens support current retirees. But the shifting demographics of an ageing society are having an impact: the retirement age keeps creeping up and most Germans still need to save up to four times their annual salary in order to retire comfortably.

Most save money in cash rather than choosing to invest, which compounds the problem by excluding savers from gains in the stock market. Few believe they have enough money to enter the market, or believe that keeping savings in cash is a safer alternative to investing.

Many people’s missteps come from a lack of financial education, says Peter Chadborn, director of Plan Money, a UK financial advisory firm. For example, many of his clients don’t know they need a bigger pot of money to derive the same income in retirement.

“Once people are informed about that, they say, ‘If only someone had helped explain that to me 10, 20 years ago, I would have been forewarned and would have made some different decisions. I’m now on the cusp of retirement and it’s kind of too late to do anything about it’.”

‘Not a windfall’

In the UK, people aged 55 or older can withdraw a lump sum of their pension to spend or invest how they like, even though the state pension age is 65.

Experts say many are missing a trick with that initial withdrawal: most opt to keep their money in cash, in a bank account that allows for quick withdrawal. Few put their money into a long-term investment, such as an annuity, that helps their money grow.

The Pensions Regulator, a UK government body, is trying to persuade retirees to take a more financially sound route than keeping their money under the proverbial (or actual) mattress. Even the most modest investments help offset the cost of inflation, which is usually pegged at around 4% per year.

People know how to save money and budget for a fixed income, but rarely understand how to invest wisely – and many begin too late

But, many of the decisions retirees make are driven by fear, says Teresa Fritz, policy manager for the UK-based Money Advice Service.

“Some people are taking the money out because they don’t trust the pensions industry. They’re worried if they don’t take it out it now, it won't be there for them in a couple of years. That’s not because of a crash in investments, but because the law might change and they might not be able to get it, or the pension company might not be there,” she explains.

“They're treating [their pension pot] as a windfall, and that’s dangerous because pensions are not a windfall. They're supposed to be there through your older life.”

According to the Money Advice Service, most retirees also underestimate how long their retirement years will last. Only planning for 20 years may mean running out of money – especially as men and women aged 65 have a 50% chance of living to 87 and 90 respectively. 

Worse yet, many of those latter years may result in higher expenses due to end-of-life care. “The thing that perhaps people aren’t appreciating is an increase in life expectancy,” says Plan Money’s Chadborn. “If we do need care, we may need care for much longer than six months.”

Ask someone who knows

Saving doesn’t get easier as we grow older, even with a salary boost. With ageing comes major expenses that can throw retirement goals off course. And when retirement looms, financial decisions take on additional gravity.

“You have this pot of savings that you have to make a decision about, and there's nobody standing over you saying if you make the wrong decision you'll be on the state pension for the rest of your life.”

People know how to save money and budget for a fixed income, but rarely understand how to invest wisely – and many begin too late.

“Historically, that's been one of the downfalls of financial advice. Someone will go to a financial adviser and say, ‘I need to save for retirement’, and the adviser will tell them to put as much as they can afford into this pension. But that's only doing half the job,” Chadborn says.

The best way to plan for retirement in an uncertain economy is through solid preparation and by setting realistic expectations. Once you know how to cover the basics, you can decide when a long-haul holiday or indulgence makes the most sense. Chadborn gives this advice:

I encourage people to put their expenditure requirements into two columns. One is the basic living costs that you want to secure with a fixed income source. Only then can you approach column two, which is your lifestyle costs: how often you want to eat out, how many cars you want to own and how often you want to go on holiday. That can be made up with flexible income, because your costs in retirement are going to keep relatively constant except for inflation.

Those facing a retirement income shortfall have harder decisions to make. In most cases, that means downsizing their home or resetting their lifestyle expectations.

The best thing people can do is seek financial help early and often, says Fritz.

“You don’t hesitate in contacting your doctor if you have a health worry. If we can get people to do the same thing with money, then we will have provided a very valuable service.”

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