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Morningstar Research Examines Retirement Costs, Concludes That Common Assumptions For Estimating Costs May Overinflate Needs

CHICAGO, Dec. 9, 2013 /PRNewswire/ -- Morningstar Investment Management, a unit of Morningstar, Inc. (NASDAQ: MORN), today published new research that examines the most common assumptions used to estimate retirement needs and lays out a framework for investors to take a more personalized approach to setting retirement savings goals.

"There are three common assumptions that many software tools and financial advisors use to come up with a retirement savings goal—a 70 or 80 percent replacement rate based on pre-retirement income, an income need that rises with inflation, and a 30-year retirement time horizon," David Blanchett, head of retirement research for Morningstar Investment Management, said. "When we looked at actual retiree spending patterns and life expectancy, however, we find that these assumptions don't hold true for many people and, on average, can significantly overestimate how much people will actually need to fund their retirement."

Many expenses disappear after retirement, such as Medicare taxes, Social Security taxes, and retirement savings. In the paper, Blanchett first demonstrates the effect on replacement rate calculations of accounting for taxable and non-taxable expenses that are no longer paid after retirement. Next, using government data, Blanchett explores the actual spending patterns of retirees, and finds that they grow at a rate lower than inflation through most of retirement and then accelerate in later years because of higher health care costs. While the difference between the actual spending growth rate and the inflation rate is relatively small, it has a material effect over time. When Blanchett modeled actual spending patterns over a couple's life expectancy, rather than a fixed 30-year period, the data shows that many retirees may need approximately 20% less in savings than the common assumptions would indicate. 

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