Will you die broke? Maybe not

A new study indicates that most Americans will die broke. You may think that's just more bad news, but read on. I'll tell you why things may be better.

Ernst & Young LLP, a major accounting firm, recently completed research on financial security in retirement. The study examines the retirement savings and other resources for Americans with $50,000 to $100,000 of pre-retirement income. It considers investment returns, volatility, health-care expenses, and takes into account the eventual death of a spouse. The study concludes that households with a defined-benefit pension as well as Social Security and retirement savings are far less likely to outlive their savings than households that don't have a defined-benefit pension.

A married couple with pre-retirement earnings of $75,000 that will have a pension has a 31 percent chance of outliving their assets. The same couple without a pension has a 90 percent chance of outliving their assets.

Talk about grim.

The study confirms what economist Alicia Munnell, director of the Center for Retirement Research at Boston College, has been warning for years -- that a smaller role for Social Security benefits, rising Medicare premiums and disappearing pensions will make the retirement of younger workers far more difficult than the lives of current and past retirees. Worse, in her book "Coming Up Short," she shows that 401(k) plans are a poor replacement for worker pensions.

So where is the hopeful news?

It's between the lines and in the assumptions of the study.

• Between the lines. Fewer workers can expect to receive retirement pensions from their employer, but it is possible to create your own pension. Just convert some of your retirement savings into a lifetime annuity. A single female without a pension, for instance, has about a 75 percent chance of outliving her assets. With a pension, the odds go down to about 25 percent. The change in the odds is similar for single males. While it's not so dramatic for married couples (90 percent down to about 54 percent), it's clear that having a guaranteed lifetime income in addition to Social Security adds major security to retirement.

This finding -- that a guaranteed lifetime income contributes significantly to retirement security -- was first noted by researchers John Ameriks, Robert Veres and Mark J. Warshawsky in late 2001. Bottom line: If you have a 401(k) but no pension, part of your retirement planning should include converting some of your savings into a life annuity.

• Assumptions. The Ernst & Young study, which was done for Americans for Secure Retirement, is like most retirement research done for the financial services industry. It assumes that we need to replace a large portion of the income we are earning immediately prior to retirement. As I have demonstrated in a number of columns -- and as Boston University economist Laurence J. Kotlikoff and I show in "Spend 'til the End" (Simon & Schuster, $26) -- most of us have never had 70 to 85 percent of our pre-retirement income to spend on ourselves. Why? Because we've made heavy-duty commitments throughout our adult lives -- all four decades preceding retirement.

Take those completed commitments (children, a mortgage, etc.) into account, and the income you need to replace in retirement is far lower than the 70-plus percent touted by the financial services industry.

If you are single, rent, have no children and never borrowed for education, the conventional replacement goals are relevant. But if you ever married, had children and worked on paying off a 30-year home mortgage, you've neverhad 70 to 85 percent of your income to spend on yourself and spouse. Consequently, the income you need to replace may be 15, 20 or even 30 percentage points lower.

Result? The probability of outliving your assets is much lower.

We can get an idea of just how much lower by going back to the Ernst & Young report. Faced with findings of such high rates of retirees going broke, the accounting firm made a second estimate. How much would the pre-retirement standard of living have to be reduced to have only a 5 percent chance of running out of money?

Answer: About one-third for married couples without pensions. Less than 14 percent for married couples with pensions. A one-third reduction in consumption takes a 70 percent pre-retirement standard down 23 percentage points.

That's right in the ballpark with all the income most adults have never had to spend on themselves.

scott@scottburns.com