Morningstar Research Examines Retirement Costs, Concludes that Common Assumptions for Estimating Costs May Overinflate Needs

Dec 09, 2013, 11:24 ET from Morningstar, Inc.

CHICAGO, Dec. 9, 2013 /PRNewswire/ -- Morningstar Investment Management, a unit of Morningstar, Inc. (NASDAQ: MORN), today published new research that examines the most common assumptions used to estimate retirement needs and lays out a framework for investors to take a more personalized approach to setting retirement savings goals.

"There are three common assumptions that many software tools and financial advisors use to come up with a retirement savings goal—a 70 or 80 percent replacement rate based on pre-retirement income, an income need that rises with inflation, and a 30-year retirement time horizon," David Blanchett, head of retirement research for Morningstar Investment Management, said. "When we looked at actual retiree spending patterns and life expectancy, however, we find that these assumptions don't hold true for many people and, on average, can significantly overestimate how much people will actually need to fund their retirement."

Many expenses disappear after retirement, such as Medicare taxes, Social Security taxes, and retirement savings. In the paper, Blanchett first demonstrates the effect on replacement rate calculations of accounting for taxable and non-taxable expenses that are no longer paid after retirement. Next, using government data, Blanchett explores the actual spending patterns of retirees, and finds that they grow at a rate lower than inflation through most of retirement and then accelerate in later years because of higher health care costs. While the difference between the actual spending growth rate and the inflation rate is relatively small, it has a material effect over time. When Blanchett modeled actual spending patterns over a couple's life expectancy, rather than a fixed 30-year period, the data shows that many retirees may need approximately 20% less in savings than the common assumptions would indicate. 

"While a replacement rate between 70 and 80 percent may be a reasonable starting place for many households, we find that the actual replacement rate can vary considerably," Blanchett continued. "Take for example a high-income couple, living in a high income tax state like California, and saving a significant amount for retirement each year. If that couple retires in Florida or Texas, where there is no income tax, the replacement rate might be closer to 60 percent. By contrast, a low-income couple saving very little for retirement and retiring in California could have a replacement around 85 percent. It's important for investors to consider their level of pre-retirement household income, expenses that discontinue after retirement, and post-retirement taxation."

To read the complete research paper, please click here.

About Morningstar Investment Management The Morningstar Investment Management unit creates custom investment solutions that combine its award-winning research and global resources together with the proprietary data of its parent company. This unit of Morningstar includes Morningstar Associates, Ibbotson Associates, and Morningstar Investment Services, which are registered investment advisors and wholly owned subsidiaries of Morningstar, Inc. The unit provides comprehensive retirement, investment advisory, portfolio management, and index services for financial institutions, plan sponsors, and advisors around the world. As of Sept. 30, 2013, Morningstar's registered investment advisor subsidiaries had approximately $176 billion in assets under advisement and management and provided managed accounts to more than 900,000 defined contribution participants.

About Morningstar, Inc. Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors. Morningstar provides data on approximately 437,000 offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 10 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. The company has operations in 27 countries.

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