NEW YORK (CNN/Money) -
In his best-selling book "The Perfect Storm," Sebastian Junger describes how a rare combination of meteorological events produced a monster nor'easter with 120-mph winds and waves towering 10 stories high.
The tale centers around the fate of a commercial fishing boat, the Andrea Gail, and the heroic battle its captain (played by George Clooney in the movie) and five-man crew waged to stay afloat. It was a battle they lost.
At the risk of sounding overly dramatic, I believe a similar confluence of factors may be conspiring to capsize the retirement plans of millions of Americans.
No, I'm not talking about the threat of job layoffs or turmoil in the stock and bond markets. I see these threats more as short-term squalls that you can weather. I'm talking about flaws that get to the very heart of our retirement planning.
Of course, like anyone who writes about retirement issues, I've long known that most of us aren't paragons of rigor when it comes to laying the groundwork for a comfortable retirement -- which is a charitable way of saying we often wing it.
But while going over the results of a recent nationwide survey of pre-retirees by the MetLife Mature Market Institute, I had a sort of epiphany: It's not just that we make bad judgments about how to prepare for retirement; it's that the interplay of our faulty assumptions can do much more damage than any one of them alone.
Here's a rundown of what I see as the three most damaging retirement-planning mistakes that, combined, can dramatically reduce our chances of achieving a comfortable retirement.
1. We underestimate how much income we'll need after we retire.
To plan successfully for retirement, you need to start with where you want to be and work backward. By that, I mean in order to know how much you must save during your career and how to invest those savings, you must first arrive at a good idea of how much income you will need in retirement.
Your target income in retirement is the core assumption of your plan, the foundation upon which everything else is built.
Unfortunately, many of us aren't realistic about how much money we'll need. When the MetLife survey asked people what percentage of their pre-retirement income they'd require to support themselves after calling it a career, more than half said they would need 50 percent or less.
Now you can argue about what the correct benchmark is. If you've paid off your mortgage, remain in excellent health, live in an area where living costs are low and prefer low-cost retirement activities like puttering around the garden, maybe 50 percent is a reasonable target. But I doubt that's going to be the case for most retirees.
Indeed, a 2001 study by Georgia State University and Aon Consulting found that, on average, people who earned between $50,000 and $90,000 needed roughly 75 to 80 percent of their pre-retirement income.
But even that figure may be low for anyone planning an active 21st-century-style retirement. Bohemia, N.Y. financial planner Ron Roge notes that many retirees rack up much more in travel expenses than they anticipate, especially if they've got kids and grandkids scattered around the country.
He says they also underestimate health-care costs, a growing concern now that more and more employers are dropping coverage for retirees. And many forget that the whole tax dynamic in place during their careers -- lowering their tax tab by piling up deductions with 401(k) contributions -- kicks into reverse in retirement. The deductions go away, and virtually every cent of retirement-plan withdrawals is fully taxed.
"I think the right figure is closer to 100 percent of pre-retirement income," says Roge. "And some of our clients need more than 100 percent."
Other research confirms this tendency for us to lowball our estimate of what we'll need. Last year, a TIAA-CREF Institute study on spending in retirement reported that "more households are surprised by how high expenditure needs are in retirement rather than by how low they are."
Interestingly enough, the researchers also found that the more effort people put into developing a retirement plan, the less likely they are to underestimate their spending. That suggests that if we make an effort, we can be more accurate about assessing our true retirement needs.
2. We underestimate how long we're likely to live.
Our grasp of life expectancy is fuzzy at best. After being told that the average 65-year-old has a life expectancy of 85 years, participants in the MetLife survey were asked what the chances were that someone 65 years of age would live beyond 85. More than 60 percent put the odds at 25 percent or less. The correct answer: A 65-year-old on average has a 50 percent chance of living beyond 85.
I think the problem -- aside from the fact that only the morbid enjoy contemplating their own mortality -- is that many people think of life expectancy as a target, the date by which you're likely to die and beyond which only a hardy few manage to survive.
In fact, life expectancy is a measurement that actuaries use to estimate the point at which about half the people of a certain age will still be living. So a life expectancy of 85 means that about half of all 65-year-olds will die at or before 85, while the other half will live longer -- in many cases much, much longer.
A 65-year-old man, for example, has about a 30 percent chance of living to 90 and a 4 percent or so chance of cracking the century mark. The odds are higher for women, and longevity is increasing for men and women alike as advances in medical technology increase our life spans.
If the only thing at stake here were our knowledge of actuarial science, this wouldn't matter. But our lack of understanding means that many of us don't have a clue when it comes to estimating how long we might have to support ourselves in retirement.
People who retire at 65 and assume that their assets have to carry them only 20 years are going to be wrong about half the time. Which means a lot of retirees could be entering their nineties with investment portfolios that are already depleted or on the verge of running dry -- not a happy prospect.
Unfortunately, a study of 24 retirement-planning software programs by the Society of Actuaries and LIMRA International, a life insurance marketing and research organization, found that even people who go to the trouble of revving up computerized software programs for retirement planning may get little guidance.
"Virtually every product just asked how long you expected to live or what your life expectancy is," says LIMRA vice president of retirement research Eric Sondergeld. "That's not a good goal to plan around since you have a 50 percent chance of living longer."
Among other things, the LIMRA study recommended that programs "educate users regarding the likelihood of survival to specified ages for both individuals and couples." I couldn't agree more.
3. We overestimate how much we can withdraw from our portfolio without depleting it.
Intuitively, most of us know that we've got to be judicious about withdrawals from our retirement portfolios if we don't want to outlive our assets. But gauging withdrawals so your money lasts as long as you do requires more than intuition; it requires a realistic knowledge of how different withdrawal rates affect the odds that your portfolio will last.
Alas, this is knowledge we lack. When the MetLife survey asked people what percentage of their portfolios they could withdraw each year to ensure their assets would last a lifetime, about a third said 7 percent. Another third said 10 percent. Only 27 percent chose the correct answer: closer to 4 percent.
Now I'm not going to say that 4 percent absolutely guarantees that you won't run dry or that any higher withdrawal rate automatically leads to disaster. Depending on how your money is invested and how the financial markets perform, you may be able to pull out more of your savings each year without depleting your portfolio too soon. But there are two important things to keep in mind.
First, unless you think the deflation crowd is right and prices will fall rather than rise in the future, you've got to plan on increasing the amount you withdraw from your portfolio each year. When investment advisers talk about withdrawal rates, what they mean (or should mean, if they know what they're talking about) is an initial inflation-adjusted withdrawal rate.
So if you have $500,000 in assets and choose a 5 percent withdrawal rate, you would take $25,000 from your portfolio the first year and then increase that amount yearly for inflation to maintain your living standard. Advisers often use a 3 percent rate for inflation. But even if it moseys along at a modest rate of, say, 2 percent, in 10 years your $25,000 withdrawal would rise to almost $30,500, and in 20 years it would be more than $37,000.
The second caveat: Down years in the market will have a double-whammy effect. Not only does your portfolio lose value because of the negative returns, it also shrinks because of your withdrawals. This means you have less capital to benefit from a market rebound, which means less chance to recoup losses.
A withdrawal rate that's fine in a bull market may deplete your assets much faster if the market slumps, especially if that happens early in retirement.
So if you want a decent shot at not outliving your money and maintaining your standard of living throughout retirement, you've got to keep your withdrawal rate down. Generally, the further you get above 4 percent, the greater the risk of burning through your assets before you die. For a look at how the odds change with different withdrawal rates, see the chart.
Any one of these erroneous assumptions can undermine your retirement dreams. Put them together, says Sandra Timmermann, a gerontologist and director of the MetLife Mature Market Institute, and "it's a lethal combination, like building your retirement on a house of cards."
Think of it this way: We get off on the wrong foot by underestimating how much income we'll need. Because of that faulty assumption, we don't accumulate a large enough nest egg to provide that income. We compound our error by assuming that our inadequate retirement stash will have to last for only 20 or so years, when it could easily be 30 or more.
Then, the coup de grace: We take our undersize nest egg that needs to last longer than we think, and we drain it at a rate that makes it likely we'll run out of money before we run out of time. Call it the Perfect Retirement Storm.
I don't want to suggest that we can plan our retirement with 100 percent accuracy. We can't know exactly how much money we'll need to live on or how long we'll live or what kind of withdrawal rate can sustain us. But we can improve our odds by planning ahead using reasonable, informed assumptions and updating as we go along.
Somehow, I doubt that this cautionary retirement tale will end up as a major motion picture. But if there's a Hollywood producer out there who sees cinematic potential in an intrepid journalist heroically alerting people about a gathering retirement storm and envisions a balding middle-aged version of George Clooney as a leading man, well, I'm available.
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Monday afternoons.
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