The End of Early Retirement

In her paper, the first level of risk Mitchell identifies is to individuals who have been called on to finance an increasing share of their own retirement as reliance on corporate pensions fades. She notes an alarming lack of understanding about important economic concepts -- such as inflation and the value of compounded interest on retirement savings -- in the United States and around the world. Saving for retirement becomes particularly difficult for people who lack this sort of basic financial literacy, she points out. The paper cites research showing that, in a nationally representative sample of Americans in their 50s, only 18% understood compound interest.

"Inflation risk is also very much on my mind because I'm concerned we are going to experience very high inflation in years to come," says Mitchell, who notes that it is often difficult for people to adjust investments to compensate for inflation occurring after they have already retired. One useful asset to include in retirement portfolios in this regard is Treasury Inflation-Protected Securities (TIPS), she adds. The principal of TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When TIPS mature, investors are paid the adjusted principal or original principal, whichever is greater.

Longevity risk, or the possibility that retirees will outlive their savings, is another issue. Research shows that many people underestimate their chances of living long into old age and, as a result, they fail to save enough money to last for the duration of their lives. Mitchell notes that some British actuaries now model survival to age 125 when pricing insurance contracts; in the U.S., the figure is age 120.

One way to avoid longevity risk is to purchase an annuity from an insurance company that delivers benefit payments for as long as the retiree lives. These plans have faced resistance because of retirees' unwillingness to turn over their nest eggs to an annuity provider, and because of uncertainty about insurance company stability. The financial crisis has created even more reluctance to buy annuities. In fact, Mitchell says, the highly public collapse of AIG has "cast a shadow" over the insurance industry, even though the company's problems did not stem from its traditional insurance business. Several life insurers have received regulatory relief allowing them to operate with depleted reserves and others have discussed seeking federal aid, which Mitchell describes in the paper as "a remaining area of concern."

Mitchell suggests that one way to protect against inadequate retirement savings is to work past age 70 and beyond. Her research shows that if people can defer retirement for two to five years, they can dramatically improve their financial security during retirement. Delaying retirement not only allows workers to save and invest more during the extra years of employment, but it also delays the day when accumulated savings must be drawn down. "For younger generations," she states, "age 75 might be a good target for early retirement, and later if possible." In today's heavily service-based economy, in which relatively few people hold down physically demanding jobs, Mitchell argues that workers can often continue to be employed much longer. She also notes that studies show working longer improves health in later years.

But employers will be most interested in hiring those who remain up-to-date in new skills, so education and retraining should be a life-long process. "Training doesn't stop after college. One must retrain every year, and not stop at age 50 or 60," Mitchell notes. "We must rethink the investment process in human capital and skill acquisition, and keep learning over our entire lives."