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Mitchell: Obviously there are people, my husband included, that would like to go out on the golf course. But the question is partly an ability to retire early.
Frankly, it’s very, very expensive to live to be 80 or 90 – or as the actuaries are now suggesting, 100 or 120 years old. One of the problems I see is that people tend to go online and work with their retirement calculators. They ask you your age and your sex, and they say, boom, you have 16 years left, or 18 years left.And then they help you try to figure out how not to run out by that point. But, of course, you might live another 20 years beyond that. And if you do, that’s the risk, the longevity risk that we have to keep in mind.
Why Start At 62?
Forbes: Given that, why do so many people – I think the majority on Social Security – start at 62?
Mitchell: That’s a very good question. Because as we know, the benefit formula is such that whether you claim at 62 or 67 or 70, it adjusts. So if you retire later, if you claim later, you get a higher benefit exactly compensating you for the additional years. But one of the things I found in my research is that the way we frame the discussion about claiming dramatically influences people’s behavior. Up until a couple of years ago, Social Security would use what they call the break even analysis, and here’s how it goes.
You go in to talk to your social security field agent, and he says, “Let’s say you’re entitled to $1,000 a month if you claim at 62. If you delay one year, you will get a higher benefit, maybe $1,127 a month, say, just to pick a number.
“But” – and they use this language – “You will forfeit the $12,000 a year that you would’ve gotten during your 62nd year of age, and you will have to live 14 more years, for sure, to make up that short fall.”
So that normal, average individual would say to himself, “Well, I don’t know if I’m going to live that long and I don’t want the government to take my $12,000 and forfeit it.” So, of course, they claim at 62. In an experimental setting, what we’ve done is we’ve shown people alternative ways of framing that claiming decision, including for example, starting out and saying, “Your normal retirement age is 67. You can take it a year early, you can take it a year late, here’s what you get. What are you going to do?”
Guess what? They all say, “Sixty-seven.” Or something later than 62. So the way we’ve been encouraging people to think, my belief is, has led them to claim early, with potentially negative effects for them.
Forbes: Does that spill over into the workplace itself? Because you get a penalty with earnings before a certain age with social security.
Mitchell: So there is an earnings test. If you claim at 62, and then return to work, up until 67, say, they do reduce your benefit. However what most people don’t know is they give it back to you once you hit your full retirement age. So everybody’s fixated on this tax, pre-normal retirement age, and nobody’s ever explained that, “Hey, you get it back, and you’re left whole, and maybe you’re healthier as well.” So that’s a big part of my research that we’re trying to think of different ways to explain this to people.
Problems With IRAs
Forbes: Now on 401(k)s, most companies do what they call defined contributions versus defined benefits.
Mitchell: Yes.
Forbes: In effect, you get to eat what’s only in the plan. There seem to be a lot of problems with it. One is over concentration; people don’t diversify.
Mitchell: From the time 401(k) plans really got started, which was in the early 1980s, employers tended to offer them without much thought to what was in the investment menu. Frequently, they would have company stock in that plan. And frequently, if there was an employer match, the match would be in company stock. So what you saw is that many average employees, not knowing what to invest in, not being expert in the market, would say, “Well, if the employer’s putting his match in stock, that must be a good. I know about this company, let’s put more in.”
And people would double up and end up undiversified. Now, with the advent of Enron and WorldCom and Tyco and all the firms where people lost a lot of their retirement nest egg, there is more understanding on the part of plan sponsors that they should actually help you diversify.
Moreover, the Pension Protection Act of a few years ago put in place certain diversified funds called target date funds, which the government views as acceptable and reasonably diversified. So if the individual employee doesn’t know what to invest in, or just can’t be bothered to choose, then it’s perfectly legal and okay to put that person into the target date fund.
Do Target Date Funds Work?
Forbes: Good concept. Does it really work, target date funds, in terms of performance?
Mitchell: What we’ve shown in our research is that, of course, there’s a million kinds of target date funds. But in our research, what we’ve shown is that it tends to get people out of the extremes. So the people that were 100% in cash end up somewhere in the middle.
And the people that were 100% in stock end up somewhere in the middle, depending on their age, because they’re age-weighted. And it’s our belief, based on historical evidence, that they will be better off in a retirement substantially by having diversified their portfolio.
Annuities
Forbes: Now, talking about longevity, when people reach their early 60s, they immediately think of a time horizon, four years, five years. As you point out, maybe it’s 20, 25 years, which means you should probably be in equities. Yet, at the same time, you don’t want to run out. Do you advise people on a mix, in terms of annuities? Should you buy a fixed annuity at age 60, at least knowing that you have that as a foundation, whatever happens?
source: forbes.com
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