THE WOEFUL STATE OF RETIREMENT SAVINGS
In the next two posts, I will explore the topic of retirement savings. In the first post, I will lay out the current savings situation for the average person and what this could mean. In the second post, I will discuss the psychology behind these statistics and provide some practical tips about how to save more.
Keep in mind that if you retire at the age of 66 (the full Social Security age for most boomers) you can expect to live another 18 years on average if you are a male or 20 years if you are female. However, many people live well beyond that. A 30+ year retirement duration is not out of the question. This will help put the averages below into perspective in regards to how long your savings must last and whether you will have enough.
Let’s start out with a couple of stats. A 401k savings plan is one of the common ways that people save for retirement these days. They are tax advantaged in that you do not pay taxes on the money until it is withdrawn in retirement, a time when conceivably your marginal tax rates are lower. Typically there is an employer match associated with a portion of your contributions – in essence, free money to help your save. So, based on the research, here are a couple of key 401k facts:
61%: The percentage of all workers who have access to a 401k savings plan.
82%: The percentage of workers who have access and actually contribute.
33%: The percentage of people who contribute and are saving “enough.”
6.8%: The average percentage of income saved by people who participate.
If you do the math, it turns out that only 17% of workers are contributing enough to have relative financial security when they retire and the average contribution of 6.8% is well below what is needed.
What about current savings balances? A survey conducted by the Federal Reserve Board found that the average savings varied by age as you would expect. However, on average these savings balances were woefully short of what would be necessary to fund the average retirement for the 18 – 30 years you will need these funds. Here is what they found in terms of average balances based on all sources of savings. Note if you are unfamiliar with the terms, we have the average and median savings. The median is the savings in the middle of the distribution among all people – 50% of people saved more and 50% saved less. Averages can be biased by people at the extremes, so medians help balance out the picture:
Age 35 or less: Average retirement savings of $25,000/median savings of $9,400
Age 35 – 44: Average retirement savings of $80,100/median savings of $37,000
Age 45 – 54: Average retirement savings of $154,900/median savings of $63,000
Age 55 – 64: Average retirement savings of $270,600/median savings of $100,000
Age 65 – 74: Average retirement savings of $267,000/median savings of $77,000
Age 75+: Average retirement savings of $105,600/median savings of $35,000
Since the average and median savings are so different, some people have saved a lot, but most have saved far less. Also, pre-retirement is a time to accumulate wealth and retirement is a time to consume wealth. So the fact that people 65+ have lower savings balance than other groups is to be expected.
Stats are stats, so let’s address the real gorilla in the room. How long will YOUR savings last? Of course, there is no single number that will apply to all. To get at the answer as it applies to you, you need to know a couple of facts about your own situation:
• At the time just before you plan to retire, what do you expect your working income to be?
• What percentage of that income will you need to maintain your standard-of-living in retirement? The common logic is that your expenses will decline in retirement. This is probably a reasonable assumption for most people. The question is how much?
• What income can you expect from other sources such as Social Security, pension, part-time employment, etc.? Retirement savings are important in that they make up for the gap between what other sources of income provide and what you need to maintain your standard-of-living. If your other sources of income cover all of your needs, then savings are irrelevant. This is not the case for most people.
• Income needs are a moving target because of inflation. For the purposes of retirement simulators, the norms are about a 3.4% – 4.0% average annual inflation rate.
• What are your expectations about average investment returns on your retirement savings balances? A good assumption for planning would be in the range of 5% – 6% annual gains. Investment returns help to offset, in part, the negative impact of inflation on your cost-of-living.
Once you have determined these five things, you will be able to estimate two key numbers: How much income you will need to come from savings withdrawals each year to maintain your standard-of-living and how long these savings will last. By the way, be conservative in your estimates of inflation and investment returns (i.e. 4% inflation rate and a 5% investment return). Solid advice is “hope for the best, but plan for the worst.”
To figure this out, you can download the “Retirement Funds Longevity Calculator” in the tools tab of this blog. You will need to gather income estimates from the Social Security website (ssa.gov) and from any pension calculators available from your company. You will also need to estimate the savings balance you expect at retirement. The output from this tool is the number of years your savings should last and your age when savings are depleted based on your inputs. This age at depletion will help you guestimate whether you are likely to outlive your money.
In my next blog post, I will address the psychological issues that lead to under-saving for retirement and provide some practical tips about how to overcome these limitations.