You’re Not Saving Enough For Retirement: A Mess That’s Getting Worse

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Findings

  • 401(k)s became a retirement staple in the early ‘80s – meaning the first generation to rely heavily on them is starting to retire now.
  • The 401(k) plans that saw the biggest losses in the 2008 financial crisis were those of people nearing retirement with a 20+ year tenure with their employer.
  • The U.S. population of older Americans is set to double its current size by 2050.
  • The fund that pays out Social Security benefits may be exhausted by 2037.
  • Average life expectancies are becoming harder to predict, given advancements in medical science and knowledge of healthy lifestyles, but scientists say the first person that will live to be 150 is alive today.

Switch from pensions

If you weren’t a member of the workforce before the early 1980s, you may not be aware that using a 401(k) to save for your retirement wasn’t always commonplace. The plans became popular in 1981 and ’82, when major U.S. employers such as Johnson & Johnson, PepsiCo, and Hughes Aircraft Company began using 401(k)s. That meant a switch from older after-tax thrift programs and pensions. In 1984, there were 17,303 retirement savings plans with a 401(k) feature, making for a total of $91.75 billion in assets. By 1996, that number had ballooned to 230,808 plans and $1.06 trillion in assets.

From NerdWallet’s Ask an Advisor:
Q: What are the basics of retirement success

Jonathan DeYoe, CPWA: “The most important retirement planning task is calculating where your income comes from when you retire. This probably seems completely obvious, but it usually isn’t. Your portfolio needs to yield more every year to keep up with inflation. Inflation is the silent retirement killer. Your income needs to increase every year just to keep up with the rising cost of living. For example, look at how much medical care services costs increase, last year rising 3.7%, according to the Bureau of Labor Statistics. So it is not enough to look at your portfolio and see if it produces enough income this year alone. It needs to continue to grow and produce more income for each subsequent year. If it doesn’t, your buying power and lifestyle evaporate.”

Retirement savings hit by market shocks

A switch to greater employee control probably looked attractive in the healthy market economy of the 1980s. But the Great Recession of 2008 has not been kind to the older generations’ 401(k)s. The Employee Benefit Research Institute (EBRI) found that, while 2008 market fluctuations’ impact on 401(k)s varied widely by age and job tenure, for people in the 56-65 age range with a longer than 20 year tenure with an employer, losses on average were greater than 25%. The reason for this is because the size of the account balance can either be affected more strongly by contributions or by investment returns. Those nearing retirement with long job tenure tend to have the highest account balances relative to contribution amounts, therefore investment returns cannot be as easily compensated for by contributions.

From NerdWallet’s Ask an Advisor:
Q: Will rolling over my 401(k) into an IRA result in higher investment returns?

David Flowers, CFP: “In general, no, your investment returns should be no different between the two retirement plans.  Both are simply tax deferred investment accounts. There could be a difference in fees, however, as a company 401(k) plan will sometimes have negotiated lower management fees on the mutual funds in the plan and the company may subsidize the administration fees that the 401(k) plan pays.”

Average life expectancy and retirement

A new ad campaign from a leading retirement services provider says, “The first person who will live to 150 is alive today” – a projection with a myriad of implications for retirement savings. Average life expectancies become harder to predict, given that advancements in medical science are accelerating rapidly. Also people are on average more aware of the health risks of behaviors like smoking or unhealthy diets, the impact of which is also hard to reliably predict on a longer timeline. Some researchers claim these trends mean the next 40 years will see the average person living much longer than the U.S. Census currently predicts.

Beyond the novelty of humans living to be 150, the general demographic of older Americans is set to explode. By 2050, the U.S. Census projects that the number of Americans 65 and above will have doubled—that’s mainly due to the baby boomers crossing into the category in 2011. That means the generation leaning heavily on 401(k)s will only get bigger.

Logically, young people in the 25-34 year old age range should be saving more and more—they will live longer, and social security (discussed more later) will be less and less of a sure thing. But the opposite is true. The EBRI found that from 2002 to 2012, the percentage of workers 25-34 who had saved for retirement at all fell from 70% to just 55%.

From NerdWallet’s Ask an Advisor:
Q: Where do I start with retirement planning, and how does that change with my age bracket?
Lyman Howard, CFA: “Surveys have shown that young workers who see their photo age-progressed to demonstrate how they might look as a senior citizen can be motivated to contribute additional retirement savings. I have tried it myself, and found meeting the ‘future me’ to be very distressing. If it helps people to set aside more retirement savings early, however, everybody should give it a go!”

Social Security won’t make up the difference

Looking at the shortfalls of traditional 401(k)s, you might assume people have an inflated idea of the role Social Security will play in funding their retirement. However, the AARP found only 43% of the general public, and only 31% of younger people (ages 18 – 39) are confident Social Security will play a meaningful role in funding their retirement. Many experts agree younger people are right to worry. According to projections from the EBRI, the expenses of fund that provides Social Security benefits will exceed income from taxes as early as 2016. By 2037, the fund is projected to be exhausted.

The proof of Social Security’s shortcomings is already being seen as the first generation relying heavily on 401(k)s starts to retire—and comes up short. Federal Reserve data, analyzed by Center for Retirement Research at Boston College, found that the median household headed by a person in the 60-62 age range has less than a quarter of what they need to maintain their standard living saved in their 401(k):

Median household annual income for household headed by person in 60-62 year age range $87,700/year*
85% of that needed for retirement $74,545/year**
Estimate Social Security $35,080/year
Gap needed to be filled by other retirement savings $39,465/year
The median 401(k) plan balance $149,400/year *
Income generated by that balance from a fixed annuity $9,073/year ***
Amount needed $30,392/year

*Circa 2009, according to data from the Center for Retirement Research at Boston College, which derived this and other numbers by updating Fed survey data, at The Wall Street Journal’s request.
**Common estimation of needed retirement income level
***Estimation provided to the Wall Street Journal by annuity provider New York Life Insurance.

From NerdWallet’s Ask an Advisor:
Q: When is the right time to start taking Social Security?
James Dowd, CFA: “If you can afford to wait, generally the economic value of your benefit will be higher given current interest rates and the fact that life expectancy is increasing. For most people retiring at standard age, for each year you delay taking your benefit, SSA will increase it by 8% per annum until you hit age 70.  This higher benefit is paid for the rest of your life (and as a reduced survivor benefit), whether you live 15 years or 25 years longer.”

About NerdWallet’s Ask an Advisor

The NerdWallet Financial Advisor Platform aims to empower consumers with the information they need to connect with advisors who can best understand their unique personal financial situation. Our tool aims to save people time in connecting with advisors and build trust in those individuals by asking questions and seeing them in action. Advisors will enjoy the opportunity to enhance their web presence and connect with a group of individuals seeking their expertise.