Governmentís Retirement Double-Talk


By Henry K. Hebeler


Congress votes itself healthy retirement benefits while the Congressional Budget Office, CBO, tries to convince the rest of the people they donít need much for retirement. Besides the obvious point that the Congress doesnít want us to focus on their benefits, itís not in the governmentís best interest to get people to save. If people save, consumption goes down which both makes the economy look bad and reduces the tax receipts that are needed to support programs that bring in votes.

First consider the retirement benefits of a person elected to the House or Senate. ( If they work in the Congress for more than five years, when they retire they and hazardous fire fighters get 70% more pension for every dollar of salary than other federal employees. Of course House and Senate salaries ($158,000 up to $203,000) on which pensions are based are quite a bit higher than fire fighters. Members of Congress, and their huge staffs, have much more attractive early retirement pension provisions and inflation protection than those of us who pay most of the taxes to support them. These pension benefits cost them a pittance of 1.3% deduction from their wages. In addition, they can save 14% of their own money in a Thrift Savings Plan, but the 5% matching funds costs are free. They also get Social Security which costs them 6.2% like all of us except the self employed who pay 12.4%. One heck of a deal!

To make the rest of us feel better, in November, 2003, the CBO released an extensive report, "Baby Boomersí Retirement Prospects: An Overview." ( This report concludes that the baby boomers are going to be much better off when retired than the previous generation. Thatís in spite of the fact that the baby boomers have been saving less, have record debts, smaller numbers will get pensions, medical costs are increasing exponentially, retirement funds have to be stretched over longer life-expectancies, and tax rates are likely to increase to support the massive build up of federal debt as well as the large increase in the ratio of retired people to the working population. Are those who assembled this report living on the same planet as the rest of us? I thought people would have to save more when pensions were replaced by employer savings plans and that increased debts hurt retirees.

How is the government able to distort information so? First, the government appoints those who are known to support the desired conclusions. Then, if any part of the committeeís findings is not compatible with the desired answer, any opposing data is rejected and/or distorted. Iíve watched this happen many times in committees to which Iíve been appointed for the Departments of Interior, Commerce, Energy, and Defense, as well as the Congress itself. Iíve seen reports unsigned and abandoned because the committee would not support the governmentís desired political objective.

Distorted historical savings rates:

I donít know any of the particular machinations that went on when developing the contents of this baby boomer report, but I can easily see that the data is distorted, and the math is bad. For example, in Chapter 3, the NIPA (national income and product accounts) savings rate data has been "adjusted." Not only that, but even the reference NIPA line without the "adjustments" has actually been modified to reduce the savings rate decline. My download of similar data from the Bureau of Economic Analysis (BEA, Department of Commerce) web site showed that the savings rate exceeded 10% eight times between 1965 and 1985, but what should be the same data shown in Figure 3 shows only one time where the NIPA data reached a high of 8% and in no year was it higher. Even the more recent low savings rates were quoted near zero by the BEA a couple of years ago and have been revised so that they now show a low of 2%.

Actually, I feel sorry for the BEA statisticians that have to come up with the national savings rate. The fact is that most of the inputs are judgmental, because there is no direct measurement of savings. In order to get an accurate savings rate, you would have to subtract accurate numbers of national consumption from national income, but there is no accurate measure of either. This is the classic problem of trying to subtract one large number from another to try and find a small difference. If there is even a small error in either the income number or the consumption number, there will be a large error in the savings calculation. So at best, if they use consistent estimating disciplines every year, the information is only indicative. Still, no amount of fudging can hide the decline in savings rates. People just arenít saving. Thatís obvious. You could also infer that just as well with the massive building of personal debt in the last couple of decades.

Distorted wealth information:

The savings data is not the only distorted information. The claim that the baby boomersí wealth is greater than the current generationís wealth is not supported by specific numbers, only by a very large list of diverse references and the following statement:

"For analyses of retirement preparedness, the relevant measure of wealth is a broad one, which includes both real assets (property) and financial assets, expected bequests and government benefits, and the value of retireesí time. It also nets out liabilities, such as credit card debt and mortgages."

Think about that statement. What is included in property? I hope this doesnít mean that automobiles and boats are a source of retirement wealth. Later weíll see that these assets, whatever they are, are supposed to earn 6% return after taxes and costs. I donít think so. How about expected bequests? I thought that this old argument wore out after the collapse of the stock market and wild projections of future investments. What is in government benefits? Elsewhere the report talks about the total value of all future Social Security and Medicare payments. Maybe it also includes anticipated Medicaid benefits. And how do they put a value on retireesí time?

To the studyís credit, the wealth statement accounts for debts. But the study says nothing about the risk. Many home buyers are getting loans with nearly zero down. A small drop in housing prices can wreak disaster for those who must sell. Their mortgages then exceed the amount of money they can get from the sale, so they effectively have to pay someone to take the property. Loans are a risky business. Thatís why they call it "Leverage." Leverage is what finished off so many real estate investments in the late eighties as well as those who borrowed money to exercise stock options more recently.

Really distorted savings requirements:

More shameful than the distorted savings data (which still shows huge savings declines) and shameful projections of "wealth" are the projections of the amount people have to save in Chapter 4 for "Analyzing Retirement Preparedness." These projections conclude that the average married baby boomer who retires at age 62 will need to have saved $330,170 while one who retires at age 70 will have to save only $77,060 in order to provide the same living standard as the couple had while working with wages of $62,000 per year.

Weíll go in to the absurdities behind these calculations shortly, but the authors should have emphasized that these are the amounts measured in todayís dollar values. This is a typical trick in the financial business: Simply imply that a person has to save a certain amount in todayís dollar values when the forecaster knows full well that the actual amount that has to be saved is much larger because of inflation. For example, if the baby boomer is now 55, that $77,060 for the 70 year old would have to be over $120,000 with 3% inflation.

So how about the calculation of the amount itself? The assumptions are atrocious and all aimed at the same objective, that is, get people to spend, not save. The amount of money needed in retirement is driven by (1) desired retirement income, (2) real returns on investment, (3) life-expectancy, (4) tax rates, (5) reserve requirements, and (6) the methodology. So letís look at each of these elements separately.

(1) Desired retirement income: Unfortunately, much of the argument about how much is needed in retirement focuses on whether retirement income should be 70%, 80%, 100%, or some other percentage of working income. The report assumes 80% based on a retiree needing less money for mortgage payments, child support, clothing, commuting, payroll tax, income tax, savings deductions, etc. These could be all valid points, but the accounting does not make additions for ever increasing medical costs, long-term-care, and additional free time activities which can easily overcome the reduced cost elements.

Using a number like 80% of current working income is unlikely to provide the income workers would need for their vision of retirement life-style. Itís totally unfair to low-income workers who had better do some real retirement budgeting by looking at the details of retirement costs including escalating medical and long-term-care insurance. Instead of implying that the projection will give the same living standards in retirement as $62,000 working income, it would be more honest to say the target is $49,600 (80% of $62,000) gross income before income tax or any other deductions.

But the report isnít even that honest. It equates 80% of a pre-retirement income less tax with a retirement income with no tax. (This is really less than 70%, not 80%, if retirement income were taxed at 15% rate.) It first reduces the $62,000 gross income to $48,943 after-tax income and then takes 80% of that, or $39,154. The $39,154 is based on an overstated working income tax as weíll see later. By overstating the income tax, they understate the $39,154 to help prove that retirees donít need much savings. Then they further aggravate the deception by assuming that neither Social Security nor investment income in retirement will be taxed. Most retirement funds are in tax-deferred accounts where withdrawals are subject to ordinary income tax. So, in addition to tax-free Social Security, they effectively assume that everyone has their investments in tax-exempt Roth IRAs. Shameful!

The fact of the matter is that a number of 70% or 80% of working income is so gross, that itís meant to apply to before-tax income, not after-tax income. Once you get into after-tax income, then you are at an unintended level of detail. For example, if you increase the amount that you deposit to an employerís savings plan, you reduce both income tax and the amount you can spend for goods and services, or if you subtract the mortgage balance from investments, as did the CBO, then you shouldnít count mortgage payments as expenses. If you want to work with after-tax income, then you need to use a competent and detailed retirement planning method.

(2) Real returns on investment: The report assumes that retirees will be able to get 3% real return on investment on an after-tax basis. Real return is approximately the actual return less inflation. So, the report assumes that the actual return is about 6% if there is 3% inflation. The actual return retired people get is the return of the market (reported in news) less investment costs, reverse-dollar-cost-averaging, and taxes. The average investment fund costs are about 1.5%. Reverse-dollar-cost-averaging has averaged 0.6% since 1926 for a portfolio with 50% stock, but those who retired from 1965 averaged closer to 2% return reduction from reverse-dollar-cost averaging. (Unfortunately, the average person has much greater reductions because of emotional selling when the market is low and buying when the market is high.) So, the before-tax return on investments has to be about 6% + 1.5% + 0.6% minimum. Thatís 8.1% after-tax or 9.5% if reverse-dollar-cost-averaging is 2%. If the money is in a taxable account with an average of 15% tax rate, thatís a before tax return between 9.5% and 11.2%. These kinds of returns correspond to an undiversified portfolio with almost 100% stock for life. Thatís most inappropriate for those in their sixties, and incredibly bad judgment for those in their eighties or nineties.

But thatís only part of the story. The investments in this case include home equity and other properties (whatever those are). In most cases, home equity is a very large part of what the government considers personal savings. If we assume that home equity is only half of the investments (Itís actually more.), and that home equity and properties increase with the rate of inflation, then the real return is zero. If half of the investments have zero real return, the other half must be 6% to average 3% for the total. With 6% real return, the investments would have to get a return of between 11.1% and 12.5% after-tax or, or with 15% taxes, 13.1% to 14.7% before-tax. Whoa!!! This is planning????

(3) Life-expectancy: One of the key assumptions is the number of years over which investments have to last. If you have $100,000 invested in a portfolio that grows at the same rate as inflation, and you only have 5 years to spend it, you can spend $20,000 (inflation adjusted) each year before exhausting investments. On the other hand, if the investment has to last 20 years, you can only spend $5,000 (inflation adjusted) each year.

Life-expectancy is the average number of years to live, so half the people will die earlier and half will live longer. The report assumes that everyone will die at age 83. Understand that the life-expectancy of a single person at age 65 is now over age 85 while a 65-year-old married couple can expect that one of the two will live to age 90. The life expectancy of a single person at age 70 is age 86 while a 70-year-old married couple can expect that one of the two will live to age 91. Thus, the study has used 83 rather than 91 life-expectancy in order to show that less money is needed for retirement.

(4) Tax rates: Taxes are inescapable and can be devastating except for those who have virtually no income. If the report was honest, it would have done everything on either an after-tax or before-tax basis. Yet the report accounts for income taxes for the worker but leaves out income taxes for retirees. Even those oversimplified free retirement programs from the Web get this point straight.

Not only that, but the report worked hard to get the highest income tax it could. That tax is likely to be significantly less if they considered that saving to an employerís plan reduces income and mortgage interest is deductible. In fact, a large contributor to the reason for saying that a person can live in retirement on 80% of the working income is that income is reduced significantly by savings and mortgage payments while working.


Itís not hard to understand why a plan based on 70% or 80% of after-tax working income can be confusing. If investments are in deferred-tax accounts with a 15% tax rate, then the age 70 requirement would be $90,659, not $77,060. Social Security can be taxed at anywhere from 0% to 85% of ordinary rates. If taxed at 50% of 15%, then the income shortfall at age 70 is not $7,246, but $9,639 so the amount of deferred-tax investment required is $120,600. If you account for 20% savings deposit to an employerís savings plan, the CBOís income tax is overstated by over $2,000 so that the income shortfall is over $11,639, and the amount of savings would have to be over $145,000, not $77,060. But this is only a consequence of the tax understatement correction. The real number is much higher as weíll see when we examine the other understatements.

(5) Reserve requirements: Practically no planning programs ask people to set aside some reserves to cover things like emergencies, helping relatives, or to replace expensive items that need periodic replacement. There is some science to determining the size of replacement reserves, but other requirements are simply unknown. The unfortunate thing is that the people with the least investments probably need the largest percentage reserves. Someone who is down to an investment level that would support expenses for only a year or two probably should not spend anything from investments for ordinary living expenses.

Yet the analysis in this report shows that $77,060 total savings together with Social Security is sufficient to support a 70 year old couple for 13 more years even though they would dole out almost $50,000 a year for expenses and taxes. Thatís pretty squeaky planning. If this was a 55 year old planning on having $77,060 in retirement (instead of that amount increased by inflation), he would be shocked to find out that with only 3% inflation, he had only $49,500 in age 55 dollars and that $25,000 car (also age 55 dollars) he planned to buy reduces the amount he can spend lavishly over his retirement to $24,500! Not only that, but if a significant part of the $24,500 was in home equity, heíd find that there are unattractive alternatives to get the cash for living expenses: Apply for a home equity loan or a reverse mortgage with points and a rate higher than he can earn on his investments, or sell the house and seek a very low rent apartment. Neither of these provides any inflation protection.

(6) The methodology: Like almost all planning analysis (except that using the Dynamic Financial Planning program from, the forecast is based on exhausting all investments at the end of life-expectancy. This is dumb planning unless you add a substantial number of years to life-expectancy. Thatís because you have a 50% chance of outliving life-expectancy. Who wants a plan that leaves you enough money to live only one more year when you actually reach 82?

A more realistic look by someone who is already age 70 (i.e., me):

Letís take the age 70 couple in the report which assumes that both partners will die at age 83 when, in fact, 50% of survivors will live past age 91. Their plan at age 70 should be based on living to an age of about 96 unless they know they will both die early. They certainly wonít have sold their home and have 100% of their investments in stock. If they have sold their home, their expenses will be higher because they now have to rent or stay in an even more expensive independent or assisted care facility. So, instead of 3% after-tax real return, letís assume 0% before-tax real return. Because of reverse-dollar-cost-averaging and counting a home as an investment, even thatís not easy for most retirees since it requires both significant stock allocations and low-cost funds.

Now letís figure out how much savings would be required for someone wanting $49,600 before-tax income at age 70 assuming that Social Security has not diminished in value even though a reduction is almost inevitable. If retiring at age 70, Social Security would then be $31,908 (based on starting Social Security at 70 per the report), so investments must furnish $17,692. A plan based on living to 96 for a 70 year old would require an initial savings level of $460,000 without accounting for reserves. For an arbitrary 10% reserve, the investments would have to total $511,000. Over a half-million dollars is much closer to what would be required to support a life-style equal to 80% of the $62,000 pre-retirement income than the $77,060 investments in the report.

But thatís not the end of this story. Letís say weíre addressing a baby boomer who is now 55 years old, expects 3% inflation, and is not going to retire for 15 years. The real target has to account for inflation in those years. Therefore the 55 year old would have to plan on savings growing to $796,000. Thatís more than TEN times the $77,060 in the report! Also, assuming a twenty years savings program with 6% return and 3% inflation, the baby boomer would have to save about $19,000 a year with an inflation increase each year. Thatís over 30% of the $62,000 gross wages! Thatís why people have to start saving for retirement much earlier.

So letís raise our arms in praise of the feds:

Hats off to you, members of Congress! You got us to believe that it was in our best interest to vote for you, yet the combination of the taxes you levy on us and the amount we should be saving leave us far short of your own take-home pay. Maybe you should let us in on that super-investment stuff that costs you only 1.3% of your working wages and gives you an almost guaranteed steady return in excess of 20% each year if you work only 16 years. Unfortunately, since you and your staffs write the laws, there is no way to reduce that lavish benefit.


And a salute to the CBO for its clever manipulation of numbers that show that the baby boomers are going to be much wealthier than the current generation, and by the time they retire at 70, they need to have saved only $77,060 instead of $796,000 to maintain the same living standards as a working couple with $62,000 income. Now the baby boomers know that they can continue to borrow without remorse and spend extravagantly. They may starve in retirement, but in the near term, they will help to pump up the economy and fatten tax revenues for Congress to spend.