Laura Rowley Money & Happiness

Conventional wisdom suggests that people are woefully unprepared for retirement. Study after study portrays most Americans as the proverbial grasshoppers, playing the fiddle with their finances while a minority of conscientious ants store up supplies for their golden years.

In 2004, for example, the Center for Retirement Studies at Boston College estimated that 43 percent of working households were in danger of having too little income to fund their retirement, even after tapping home equity.

Singing a Different Tune

Now a group of economists is offering a wildly contrarian view: People may be saving too much for their retirement. A few go so far as to suggest that the financial services industry is deliberately encouraging over-saving because it profits from managing such assets.

Consider a recent study conducted by Paul Smith and Lucy McNair of the Federal Reserve Board, and David Love, an economist at Williams College. They found that 88 percent of all households with breadwinners over age 51 had accumulated sufficient resources to finance adequate consumption in retirement.

A separate study by John Karl Scholz, an economist at the University of Wisconsin, Madison, and two other researchers found more than 80 percent of households headed by Americans born between 1931 and 1941 have accumulated their optimal wealth targets for retirement.

The other 20 percent missed their goal by a relatively small margin, according to the study published in the Journal of Political Economy.

The Wrong Message?

"I was very surprised by the research," says Scholz. "If you pay even cursory attention to the popular financial press, the message is that Americans are blowing it in their retirement."

His study looked at more than 6,000 Americans who took part in a detailed Health and Retirement Study, which surveyed them on income, job history, pensions, housing, retirement plans, health, family structure, and net worth, among other topics.

The researchers then constructed an elaborate "life cycle model" that captured key features of a household's consumption decisions, potential health shocks, survival probabilities, income tax liabilities, and projected Social Security benefits.

"The behavior underlying our model requires fairly sophisticated mathematics to solve," says Scholz. "It's a model professional economists use to think about this issue -- it doesn't translate into advice [for the consumer]."

The 'Rules of Dumb'

Boston University economist Lawrence Kotlikoff argues more economists should be developing tools to advise the consumer. "There is a risk from overdoing it when you're young -- you squander your youth rather than your money," he says. "It makes no sense to have huge bundle in your 401(k) and have not gone to Hawaii, or gone skiing with the kids. It's not all about the end game -- it's about the middle game and the short game, too."

Kotlikoff has created dynamic programming software for individuals, incorporating the kind of economic modeling used in academic research. Such models focus on "consumption smoothing" -- or putting away just the right amount to maintain one's standard of living over time -- rather than following rules of thumb, or what Kotlikoff calls "rules of dumb."

Kotlikoff suggests that people have been duped by tainted advice, and a small calculating mistake can become greatly compounded over time. "The simplistic calculators on companies' web sites are primitive tools that have no connection to modern mathematics or economic theory," he says. "Five-second financial checkups are really financial malpractice."

In his recent paper "Is Conventional Financial Planning Good for Your Financial Health?" Kotlikoff ran a theoretical household through the retirement calculators on the web sites of Fidelity, Vanguard, American Funds, and TIAA-CREF, and found the savings recommendations ranged from 36 to 78 percent too high, compared to his software's calculation.

Meanwhile, though many planners base their retirement recommendations on a steady level of consumption, a review of federal data found that seniors spend less as they age.

In an article in the Journal of Financial Planning, Wisconsin planner Ty Bernicke found Americans over 65 spent an average of 26 percent less than their younger peers. Bernicke cites research that suggests the spending cut is voluntary, rather than in response to a lack of resources.

'Optimal' May Mean 'Just Getting By'

But before you trade in your 401(k) contribution for a whirlwind vacation, consider a few problematic factors. First, don't confuse "optimal" wealth accumulation with opulence. Some people have enough to retire on only because they've had very low incomes throughout their lives, and Social Security replaces a sizeable chunk of their earnings. About one-third of retired workers depend on Social Security for 90 percent or more of their income.

For example, Scholz found that in the generation he studied, householders with the lowest lifetime earnings had an average of 4.6 children. "Suppose you have five children. When the kids are in the house, they're eating all of your resources," Scholz says. "Once the kids are out of the house and you adjust the consumption needs of the remaining couple, their optimal wealth accumulation is next to nothing. Social Security is replacing 60 percent of income. This rosy language of ‘optimal' still may mean people have austere standards of living in retirement."

In addition, Scholz's study examined people born between 1931 and 1941 -- a demographic group greatly influenced by the lessons of the Great Depression. One could argue that the event would inspire them to save more prodigiously than the baby boomers born between 1946 and 1964.

Moreover, if 88 percent of people over age 51 have saved enough to retire, as Smith, McNair, and Love's study indicates, why are so many people in their 70s getting up and going to work every day? The percentage of men age 70 to 74 who are still in the workforce has risen five percentage points over the last decade to more than 20 percent, according to an analysis by the Population Reference Bureau. Of that group, more than half were working full-time.

A Cautionary Approach

I suspect I'm one of the dupes who's saving too much for retirement. For years, I've followed a "rule of dumb" -- putting away 10 to 15 percent of my income annually. My goal is to replace 80 percent of my current income in retirement, excluding home equity and Social Security. (I'm dubious about the program's long-term sustainability.)

I may need less than 80 percent of my current income, since many of my costs will disappear in retirement: school tuition, college savings, the kids' extracurricular activities, the mortgage (and I won't need to save for retirement anymore).

But I err on the side of caution, because saving for retirement squeezes out luxuries -- a second car, better vacations -- rather than necessities. Economists should turn their research into more accurate models for people who could use additional funds today to stay out of credit card debt, or pay for education and other staples of life.

If anything, the rocket science of figuring out retirement needs underscores the importance of not scrimping on your health. Spend the money on the gym, a weight management program, or the smoking-cessation class today. Then, if you end up with too much in retirement, you'll have the energy to enjoy the windfall; if you end up with too little, you'll have a better chance that medical expenses won't put you into bankruptcy.