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Retirement: A Contrarian’s Perspective

Frederick Vettese, retirement guide

With Frederick Vettese, Chief Actuary of Morneau Shepell, Author of The Essential Retirement Guide, A Contrarian’s Perspective

Behind every pension and insurance plan, there is an actuary who crunches the numbers in order to advise his clients (who are insurance companies and pension consultants)  how much they must fund these plans so that all benefits can be paid out.

As the title of Frank Vettese’s book, The Essential Retirement Guide, A Contrarian’s Perspective, implies, there is more to the actuarial business than one might expect.

Once the retirement program is designed for the client, funding recommendations continue because future investment returns, mortality rates, life, in general, can change.   The job of the actuary, in many cases, is to dispel the myths around retirement, and one of these myths is that the employee will need an income of 75% of his salary at the point of retirement.  Frank’s calculations have shown that, in fact, even someone with above-average income spends only about 35% of his gross income on himself during his working career.  The rest of that income, roughly 65%, goes to income tax, child-raising expenses, mortgage, and savings, most of which ceases or severely decreases upon retirement.

However, even though the 75% target retirement income is overstated, the actual amount in dollars needed for a secure retirement may still be significant. Frank calls this the “wealth target” in his book.   The “wealth target” allows for lower interest rates, which he predicts will remain so for the next 20 to 30 years.

Because Steve does a lot of retirement modeling for his own clients, he asks Frank how the decline in spending over the years—when you’re into your 80s, for example—affects retirement calculation. Frank refers to what he calls the “tipping point”, that point 10 or 15 years past retirement age when people spend less because of changing circumstances: Health declines, travel is less frequent, and many of the other early retirement activities just cease.

Referring back to his statement that interest rates will remain low, Frank states that changing demographics is behind this concept. Globally we are an aging population which means that roughly 40% of the world population is over 50 which is the tipping point for higher interest rates declining. The under 50 age group who are out there borrowing for student loans, mortgages, and car loans, can’t make up for these percentages.

Recognizing that the average life span is 82 for a man and 86 for a woman, Frank and Steve discuss the value of annuities for retirees and conclude that the safest path, if annuities are to be part of your retirement, is to put only half into an annuity and the other half into investing.  Combined with Social Security which is indexed to inflation, if you follow this advice, the retirement years should remain golden.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: My next guest is Frederick Vettese. He’s the Chief Actuary of Morneau Shepell and has spent his entire career providing retirement consulting and actuarial advice to human resources and pension plans.

He has written the book, The Essential Retirement Guide, A Contrarian’s Perspective, and I’ve asked him to join me today for that reason exactly. It’s a contrarian’s perspective to a lot of the information that you hear as you go about your daily life reading material on retiring. Welcome to the show, Frederick.

Frederick Vettese: Good morning, Steve.

Steve Pomeranz: You’ve spent your life as an actuary, and I don’t think a lot of people really know what an actuary does. Can you tell us a little bit about that?

Frederick Vettese: The actuaries are the people who crunch all the numbers behind the scenes for insurance and pensions. For example, as a pension actuary, I would be the one who’d be telling my clients how much they’d have to be funding their pension plans in order to make sure that they can pay out all the benefits. Insurance actuaries would be the ones who figure out the premiums for life insurance and such.

Steve Pomeranz: How does this work on an on-going basis? It seems to me that once you’ve kind of done the calculations, you’re kind of done; so what are some of the other things that an actuary has to do in order to make sure they’re giving the best advice?

Frederick Vettese: First of all, the funding recommendations are on-going because the situation keeps on changing. Your prognosis of future investment returns will change, mortality tables change, the client’s own situation will change because they’re funding a pension plan and they have pension assets and they may not grow as fast as we assumed they were going to grow, and they may grow faster, so that goes on.

The other thing we do, too, is give them ongoing advice about pension plan design, so that they have something that actually works for their employees.

Steve Pomeranz: Sure, so you see the retirement situation or, in some cases, dilemma from a completely different point of view. You’re looking at the big numbers and actually able to quantify what’s actually going on versus some of the myths that surround retirement and also a lot of the information that comes from what you call vested interests. When you read the information that’s out there, that’s available to the general public and you think about these vested interests, what are you talking about there?

Frederick Vettese: If you look at the websites for the big mutual fund companies— and I guess you’d know the names—they’ll tell you that people need a retirement income target of 75 percent of their final pay. That’s how much income they need in retirement, and then, if you scroll down or look in some of the attachments, you find out how they got to those numbers, and it just doesn’t make any sense. As an actuary, that’s one of the things we do. We crunch numbers, and I work them out, and it’s impossible that they could be anywhere close to 75 percent, but that’s the conventional target.

Steve Pomeranz: That’s important, so let’s talk about that. You have the average person and they’re thinking about what their income is right before retirement, and they’re trying to make some kind of a calculation in the future, “Exactly how much am I going to spend in retirement?” You think, “Well, I’m not going to spend 100 percent of what I’m spending today, but 75 percent sounds like a reasonable figure.” Why is that number so wrong?

Frederick Vettese: Your average person, let’s say, who has somewhat above-average income, ends up spending only about 35 percent of their gross income on themselves during most of their working career, because you break it down. First of all, a big chunk of it, maybe, let’s say for somebody earning $100,000, to pick a round number, they might be paying $20-$25,000 in income tax alone, probably $20,000.

Steve Pomeranz: The first haircut off that 100 percent is taxes, right?

Frederick Vettese: Right. Income tax, yeah. Second haircut is going to be child-raising expenses and, if you have a couple of children, it’s going to be $15 or $20,000 a year, on average, and, obviously, anyone who puts their kids in private schools or summer camps knows that number could be a lot bigger than that, but that’s going to be another $15 or $20,000. Then there come mortgage payments that typically go on for 20 or 25 years, and that’s another $20,000 off of that number. Finally, there’s actual saving for retirement itself, so when you take all those numbers off, you’re only left with about 35 percent of your gross income that you can spend on yourself.

Now, in retirement, all those things I just mentioned go away, or they should go away. You should have your house paid off. You children should be self-supporting, by that point in time. You’re no longer saving for retirement, and, finally, even income taxes end up being a lot less in retirement because of… all kinds of reasons.

Steve Pomeranz: There’s a huge difference when you’re calculating your future needs for retirement if you’re using, let’s just use your $100,000, if you’re using the need for $75,000 of income. I mean, how much money would you have had to accumulate to support that $75,000, assuming no other sources of income like Social Security versus only to support $35,000? Do you think that a lot of the calculations as to how much people are going to need are overstated because of that?

Frederick Vettese: There’s no question that the retirement income target is overstated for all the reasons we just mentioned. The actual amount in dollar amounts and dollar terms might actually still be significant. I call that the wealth target in the book, i.e., the lump sum amount of money that you need at the point of retirement to meet all your needs in retirement. And the reason that lump sum amount is still going to be large in the future is because we’re not going to be seeing 8 or 10 percent returns anymore as we have in the past.

In the book, I outlined interest rates are going to be staying low for the next 20 or 30 years.

Steve Pomeranz: Yeah, I want to get into that in a minute.

Frederick Vettese: We’ll talk about that later, but, because of that, the amount you actually need is still going to be substantial, so good news, income target. Bad news, the amount you need to reach that low-income target is still substantial.

Steve Pomeranz: We do a lot of modeling for retirement of this nature, and one of the aspects that you mention in your book was the fact that spending does decrease with age. So here we are, number 1, looking at the retirement income target as being less than expected, let’s say from 75 percent down to 35 or 40 percent, but even that 40 percent that you’re spending over the years as you get into your 70s and 80s and so on, that actually declines as well. So how does that affect the retirement calculation?

Frederick Vettese: The way it affects it is that the number ends up being lower, and I estimate it would be lower by 10 or 15 percent versus if spending did not decline. When I talk about spending declining, I mean in real terms, like after inflation. I cite studies from Germany, the United States itself and Canada in the book, and I talk about how the tipping point seems to be ages 70 to 74.

Up until that point in time, your spending does generic for hydrocodone keep on going up. You retire in your 60s, and you keep on spending at the same rate pretty much for the first 5 or 10 years of retirement, but then you reach that tipping point, and after that, you start spending less.

There’s another recent study that was very extensive, very robust from the UK that shows the same thing, same tipping point, 70 to 74 and then less spending in 70s and 80s. The reason why people spend less is not because they have less money because they actually end up saving a higher percentage of their pay when they’re 80 than they ever saved when they were 45, which of course is ridiculous.

Steve Pomeranz: Why is that?

Frederick Vettese: The reason why they do it is because they just don’t seem to want to spend or maybe can’t spend as much anymore, and so all the various studies are citing the same things. They’re saying, “You’re hobbled by arthritis, by Parkinson’s,” by whatever it might be, “your spouse might have died, you have less interest in traveling,” and so on. “There is less inclination to spend and less ability to spend once you reach about age 75, roughly.”

Steve Pomeranz: Yeah, I guess you kind of have all the stuff you’ve ever needed in your whole life, pretty much you’ve bought everything.

Frederick Vettese: Yeah, you’re not buying sofas anymore. My parents didn’t buy any sofas for the last 40 years of their life.

Steve Pomeranz: Right. The book is The Essential Retirement Guide, A Contrarian’s Perspective. My guest is Frederick Vettese, the Chief Actuary, which he does for a living, and he has written this book from an actuary’s point of view.

You mentioned investment returns in the future. One of the key inputs when trying to figure out what future rates of return are going to be is the amount of return you’re going to earn on those savings, and you stated in your book that you think that interest rates are going to stay low for the next 20 years. That’s quite a statement. Why do you think that?

Frederick Vettese: First of all, I would say that whenever anybody is giving you an investment forecast and they say, “This time it’s different,” you always have to be suspicious because it almost never ends up being different. This time, it actually is different, and that’s because of demographics.

What has happened is our population is aging and, very generally, people over age 50 tend to be savers and people under age 50 tend to be borrowers. For the past half century or longer, we’ve had a lot more borrowers than savers because we’ve had a fairly young population here in North America, and even in other parts of the world, like Japan. Lots of young people means lots of borrowing going on for student loans, car loans, and mortgage payments, and so on, and so there was a lot of demand for money, and then it’s just a supply and demand. The higher the demand, the higher the interest rates.

Twenty-five years ago we would have seen real interest rates after inflation on state bonds of, say, 4 or 5 percent, real interest rates. Today, real interest rates are just about zero percent, and the reason is because our population has aged. This is a world-wide phenomenon. We actually should have seen this coming long ago because it started in Japan in the 1990s where they reached their own tipping point in terms of an older population around 1992, ’93 and they’ve had extremely low-interest rates, say around 1 percent, nominal rates on bonds, for the past 25 years.

Steve Pomeranz: Let me interrupt for a second because it seems to me that we don’t want to … We went to make sure that we understand that we’re not painting with too broad a brush here. The United

States is not Japan with regards to demographics. I mean, they have a much older population. We have much higher immigration rates than they do.

I don’t have the facts in front of me to argue these points, but these are the things that I notice and that I have read and, also, it’s not just domestic trade anymore. It’s worldwide trade and corporations need money to expand and to borrow, so this seems like the main thesis that is just demographics seems to be a little bit too singular. What do you think?

Frederick Vettese: First of all, the US is not Japan. However, there seems to be the same tipping point everywhere. So Japan, if you look at the population over 50 versus under 50, and you take that ratio, the tipping point seems to be at 40 percent. When you have more than 40 percent are over 50, that’s when interest rates really seem to take a dive.

That’s what happened in Japan in 1993. It happened in Canada around, I think, 2010. It happened in Europe a little bit earlier, and, lo and behold, ever since the Great Recession of 2008-2009, we see interest rates that are around 1 or 2 percent pretty much everywhere in the developed world.

The US has now reached that 40 percent tipping point in terms of the demographic ratio I just mentioned, and you talk about world trade and it’s not just one country, so you might think that maybe China’s going to bail us out because China’s got a young, dynamic population, huge growth and they’re going to export all that. Even China, even China, which has always had a very low ratio of savers to borrowers, is going to be over that 40 percent tipping point by the year 2020, so it’s going to be a worldwide phenomenon.

Steve Pomeranz: We have to get all our children and grandchildren to procreate, I guess. That’s going to be the answer to this.

Another input, when trying to figure out the viability of your savings and retirement is your expected lifespan. In your book, you pointed to a site that you can actually put in some criteria and it’ll actually tell you what the average, what you can expect for your lifespan, but seriously, nobody really knows how long their lifespan’s going to be. How would you recommend people thinking about that in the calculation?

Frederick Vettese: The way I would recommend it is for the vast majority of us, I would just assume it’s going to be an average life span or maybe even a bit more than average, and, as a result of which, it means that we want to be thinking about certain kinds of instruments like buying an annuity.

For a small proportion of people, they kind of know that they’re going to have a shorter lifespan. If you’re grossly overweight, if you’ve always been a smoker, you’ve got emphysema, if there’s other problems going on, like cardiovascular disease and so on, and you just know that you’re not going to have the average lifespan, then you may want to be avoiding buying annuities, but for most of us, we expect it’s going to be an average.

Steve Pomeranz: Let’s talk about annuities for a second, but before we get into that, what is the average lifespan for a male these days who attains the age of 60?

Frederick Vettese: For a male who attains the age of 60, it would be around 22 years, roughly.

Steve Pomeranz: So 82 is the average.

Frederick Vettese: Roughly, yeah, but 82 if you got to age 60, yeah, 82. For a woman, it’d be more like 86.

Steve Pomeranz: Those are averages, so it’s really difficult. I guess half live longer and half don’t, right?

Frederick Vettese: That’s exactly what it means, yeah.

Steve Pomeranz: What is the chance, I guess, when you get to a certain age, like let’s say when you get to 85, what are the chances of you living to age 95? I mean, it must diminish pretty quickly.

Frederick Vettese: If you got to 85, your chances of getting to 95 are lot better than they looked when you were only 60, but an interesting thing, so what has happened is, mortality has been getting a lot better at the older ages for the past 20, 30 years. By the way, this is more true in Canada and Europe than it is in the United States.

It has been a bit of a quandary as to why the US is lagging the rest of the world in terms of mortality improvement. It could be all kinds of reasons.

Steve Pomeranz: That’s a complicated issue to discuss in 2 minutes.

Frederick Vettese: Yes, it is.

Steve Pomeranz: We only have about a minute left. You mentioned the word annuities, which is kind of a dirty word these days, especially the kind of tax-deferred annuities. Immediate annuities, which pay you a guaranteed payout, I think, have a lot to say for themselves, but they are quite expensive because of low-interest rates these days. Why do you still recommend them?

Frederick Vettese: Low-interest rates shouldn’t really have any bearing on whether you buy an annuity or not because what are you going to do with the money otherwise? A lot of people are putting their money into fixed-income instruments anyway. It might be bonds or it might be some kind of guaranteed certificates.

Steve Pomeranz: All right. I’ll buy that, but let me ask you this question. You’re really only getting, generally, the annuity payout, you’re kind of getting your own money back for a rather long period of time. So it’s a bet that after that period of time when you’ve actually received your own money back, that’s a bet between you and the insurance company, but that period seems, I mean, it doesn’t seem like it’s favored… it’s in the favor of the annuity holder. It’s more in the favor of the insurance company.

Frederick Vettese: Right. The break-even age might be around 80, 85, right? Here’s the thing about that bet. If it pays off for you, i.e., you live a long time, then you’re going to enjoy the rewards. If you lose the bet, it’s only going to be because you die early, and so you aren’t actually going to be suffering had you lost the bet because you’re dead.

Steve Pomeranz: But the value of the payout decreases because of inflation starting at age 85 because it constantly gets worn away because the value of a dollar is worth less in the future, so you may get money for the rest of your life, but the value of that money is greatly depleted.

Frederick Vettese: I don’t think anybody should be putting their whole nest egg into an annuity. I kind of like the idea of putting in about half of your savings into an annuity and the other half you keep on investing.

The business about it not being inflation-protected, based upon the earlier argument that we spend less as we get older, that’s okay because you still have your other half of your savings. Then, on top of that, you’ve got Social Security, which is indexed to inflation, so you have enough indexation to meet your needs.

Steve Pomeranz: Very interesting. Unfortunately, we’re out of time, but these are wonderful points to consider. My guest, Frederick Vettese, Chief Actuary of Morneau Shepell.

Thank you so much for joining us, Frederick.

Frederick Vettese: Thank you.