Rescuing baby boomers' retirements

Close to 80 million baby boomers have retired or will shortly and many, if not most, are woefully ill-prepared for what may be more years spent out of work than spent at work. For most, typical wealth holdings represent less than three years of earnings. A veritable baby boomer retirement crisis.

Then there are today's derisory interest rates. The current yield on long-term Treasury Inflation-Protected Securities, or TIPS, is negative 21 basis points. This leaves Social Security as the major asset in most boomers' treasuries.

Combine these concerns with the ongoing rise in out-of-pocket health care costs and rising prices that exceed their Social Security cost-of-living adjustments, most boomers need a financial lifeline.

ADOPTING AN ECONOMICS-BASED APPROACH TO FINANCIAL PLANNING

We economists don't think much of conventional financial planning. Indeed, there isn't a single top finance program in the country that spends even an hour teaching conventional financial planning. The reason is that it contradicts, almost entirely, all economics principles of how to handle a household's personal finances, instead focusing simply on dangerous assumptions (“How long do you think you’ll live?) and pie-in-the-sky thinking (“How much would you like to have saved by the time you retire?”).

The alternative is an economics-based financial planning method, focused on the bottom line — the household's living standard.

This approach to financial planning has four principal goals:
• Consumption smoothing (maintaining the household's living standard through time).
• Safely raising the household's living standard.
• Making cost-effective lifestyle decisions.
• Investing in light of the downside living standard risk.

With these outcomes in mind, I've spent the last 28 years developing financial planning software through my company Economic Security Planning Inc. and have created software that challenges long-held, clearly obsolete assumptions held dear by the financial planning industry.

Achieving these four goals is critically important for millions of baby boomers if they hope to avoid a financial nightmare.

HOW TO IMPLEMENT AN ECONOMICS-BASED APPROACH TO FINANCIAL PLANNING

The first step is determining an affordable and sustainable living standard. It may be painful to compute, but overspending is the last thing boomers should do. The calculation needs to consider the financially worst-case longevity outcome, namely living to the maximum age of life. Planning to die on time — at your “life expectancy” — is extremely risky.

Next, boomers should optimize their lifetime Social Security benefits and find the retirement-account withdrawal strategy that minimizes their lifetime taxes.

For most boomers, this means waiting till age 70 to collect one's retirement benefit and taking retirement account withdrawals in one's 60s to get by. Clearly, working as long as possible or going back to work can materially raise one's future sustainable living standard. But so can downsizing one's home, moving to a state with no income tax and low housing costs, choosing an affordable Medicare Advantage plan, and securing a safe, positive real return by paying off one's mortgage, student loans, credit card balances and other consumer debts.

Of course, there are other "money magic" tricks that seniors can consider, including sharing a residence with their children, taking in roommates, renting out a part of their home, Airbnb’ing a room in their house and possibly, using a platform to occasionally rent their car, or doing a sales-leaseback with your kids to untrap trapped equity. (I'm not a fan of reverse mortgages.)

In terms of spending, make sure that costly lifestyle choices, like taking expensive vacations, are really worth their price in terms of your permanently reduced living standard.

As for investments, I recommend forming a living standard floor based on investing in TIPS and putting some money in the stock market, but not spending it until the stocks have been converted into TIPS. I call this Upside Investing. It treats playing the market like going to Vegas. Most people leave their credit cards back at the hotel and only spend winnings, if they occur, after they've left town.

Following these steps won't turn clay into gold, but they will keep you safe, and they may materially raise your living standard in retirement.

Laurence J. Kotlikoff is professor of economics at Boston University, a personal finance expert and New York Times best-selling author, and founder of Maximize My Social Security and MaxiFi.