Isn’t a $50 million account the same $50 million whether you are young or old?

The first thing that makes the retirement problem quite different from other financial concerns is that there are differences in what I call "personal states." For example, I could be alive and in fairly good health, or alive but in such poor condition that I reside in a skilled nursing facility, or I could be dead. So that’s three. Wealth means different things to me according to my personal state.

Economists use a concept called "utility functions" to summarize how you think about money. You talk about what utility I will get from my money in 2016. You try to measure how much happiness it gives me today to contemplate the fact that if I’m alive in 2016, I’ll have a certain amount of wealth. You are going to make some decisions today that will determine, in part, how much money is going to be available to you, to your spouse, to your heirs, in whatever personal states you may find yourself in the future. It requires that you bring together a whole spectrum of considerations, from insurance to investment planning.

It’s always good to hear a dismal scientist talking about how to measure happiness. Have your personal demographics contributed to your interest in retirement economics?

Well, yes. I wanted software to figure out my needs, but nobody has provided it. By the time we got Financial Engines to the point where it could really help people in their 40s or 50s, I was in my 60s.

The rule of thumb for withdrawal rates in retirement is that you can conservatively spend 4 or 5 percent per year. This is inexact. Why haven’t academics offered any alternatives?

Probably because productive academicians are young, at least from my vantage point. Their students are even younger. It is partly a matter of what attracts one’s attention. Moreover, the practical importance of dealing with these issues has increased relatively recently. In the old model for handling retirement via social security and defined benefit plans, your retirement income was mostly or completely insured. You were guaranteed a level of income no matter how long you lived. But we now rely more on 401(k) plans. The majority of people with such plans take lump-sum distributions at retirement and bear the risk that they may outlive their assets. But unless you are as happy to have your kids spend your money as to spend it yourself, it may make good sense to buy an annuity with some portion of your wealth. An interesting question is this: Why did we as a society think that people should get annuity incomes from public and private retirement plans, only to find that when we gave people a choice, they mostly chose to bear the longevity risk themselves?

Will answers to the retirement crisis come from economists like you? Or should employers and the government be the ones to solve it?

Everybody has some responsibility–employers because of the role they play in funding retirement, government because of the role of payroll taxes, and economists because I believe they can, and should, contribute to increase social welfare.

And individuals have to invest wisely.

The goal is to determine the set of investments that will maximize your happiness, taking into account all possible future personal states and all possible market outcomes. Your job, aided no doubt by an advisor or financial manager, is to pick investments, and perhaps insurance, that will maximize your happiness, taking into account all the possibilities in each table for each future year.

How will using rigorous economic analysis change people’s choices?

Let me give you a prototypical example. Let’s assume that I don’t know if 10 years from now I’m going to be in a nursing facility or if I’m going to be going on cruises. Let’s say I have some money and I can buy a variable or fixed payout annuity that will pay off if I’m well. And I can buy another one that will pay off only if I’m in a nursing home. These annuities do not exist now.

So what I want to do is buy a nursing home annuity that will pay me pretty much what I need for a good nursing home, but not much more. So it will be either a fixed annuity or something pretty close to it. On the other hand, I’ll want to take some risk with the annuity that pays off if I’m healthy, because if the financial markets are kind, the payouts will enable me to take some great cruises and stay in wonderful places, while if the markets are not so kind to me, I can get along OK. If I drew curves to represent these various scenarios, they would cross somewhere.

With present products, what can I do? I can buy a standard annuity, variable or fixed, that pays whether I’m sick or well. Then I can also buy an additional long-term care policy that will increase my income by some amount if I’m in the nursing home. But that doesn’t allow me to do what I really want to do. The solution is not so hard. The insurance companies just have to produce some new products.

Not so hard, but the financial markets alone present an infinite number of possible outcomes.

Let’s assume there can be 100 different possible states of the market in any given year, so you plot all of them. I’ve done that in some experimental work, and I think that’s probably perfectly sensible. It is better than using rules of thumb that are not very well grounded in personal issues.

Contrarians say people are saving too much because many models do not account for so-called consumption smoothing, or people’s natural tendency to self correct.

I’m sure there are some people who are saving too much, but I worry more about those who are saving too little. The real issue is whether or not people who are saving for retirement know what they will be able to do with the amount of money they’ll have if they keep on their present course.

It’s irresponsible to overgeneralize. What’s responsible is to say, "Let’s do our damnedest to help people understand what the alternatives for them are pre- and postretirement," so they can make informed judgments as to how much they personally want to save, and, once they get there, what they want to do with it. We need to get a lot of information from individuals to do what I’m talking about. And if people have no notion what cancer treatment or a top nursing facility will cost in real terms, that’s a problem. For good and bad reasons, we’re in a regime pretty much worldwide in which we have decided individuals are going to have to make these decisions pretty much on their own–and they just need a lot of help.

Why is it hard for some people, even people with a great deal of assets, to save, invest and make sound decisions about retirement?

Why is it hard to save? Because it’s more fun to spend! There are some really big issues of behavioral economics here. Brain research indicates that it is important to try to get people to address these issues using the front of the brain–the prefrontal cortex–where they can reason and analyze. Unfortunately, many of us succumb to the emotional impulses of the older reptile brain rather than the reasoned responses of the newer reasoning brain.

That does sound like a job for behavioral economists, or maybe psychologists.

No question about it. People really don’t want to think deeply about their inevitable demise. I experienced this with my neighbor. We were talking, and I said, "I know how old you are and how old your wife is. Let me produce a plot of the probabilities, year by year by year, that you will both be alive, that only you will be alive, that only she will be alive and that you both will be dead." I produced the graph and gave it to him the next day. Neither he nor his wife wanted to see it. But without seriously considering such information, how can you even begin to make sensible decisions about how much money to spend now?

Do you think your current research is Nobel worthy?

No. Most scientific progress comes from gradual accretion. For good reasons the Nobel committee will identify one, two or three people with a body of work. Among other things, this helps popularize the importance of science in the public mind. But will one or two people rise sufficiently above the many, many researchers who are doing important work in the field of retirement economics to be worthy of being singled out? Perhaps. But I view my work in this area as applying a combination of fairly standard economics and fairly standard actuarial and behavioral concepts to this particular class of problems. I certainly don’t anticipate anyone looking at anything I’ve done or am likely to do in this area and saying: "Wow, nobody thought of that. What a huge breakthrough that was."

What was it like to win a Nobel Prize?

When people ask, I say, "First of all, it’s really nice. If they offer you one, you should take it." It’s an incredibly heady experience, to be sure.