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Young Workers Already Face a Retirement Crisis

Dec. 19, 2014
Young Workers Already Face a Retirement Crisis
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By David Cretcher

Learn more about David on NerdWallet’s Ask an Advisor

Young workers today face a retirement crisis. They will not retire as comfortably as their parents. They will find it harder to save money and more difficult to accumulate wealth.

How can we make such pronouncements when young workers still have several decades until retirement? Economic trends tell us so. Consider that current retirees are enjoying a retirement built on an engine of:

  • Employer-provided defined-benefit pension plans
  • Long-term 401(k) growth from increasing stock values and high interest rates
  • Appreciating real estate
  • Rising wages
  • Affordable college tuition
  • Confidence in the Social Security system

The situation is nearly the opposite for today’s young workers. They face:

  • A sharp decline in traditional pension plans
  • Meager 401(k) growth from flat stock values and extended low interest rates
  • Slow-growing long-term real estate values
  • Low or even negative wage growth
  • Expensive tuition financed with debt
  • Uncertainty about Social Security

Let’s look at a few of these strong headwinds that are buffeting younger workers.

Fewer defined benefit plans

The share of workers who have a traditional “defined benefit” pension has decreased from 38% in 1980 to 14% today, according to the Bureau of Labor Statistics. To make up for the loss of this key source of retirement income, workers will need to save more in their 401(k) and similar “defined contribution” plans. But even saving more brings its own difficulties. That’s because of…

Low interest rates

In 1980, $1,000 invested in a 30-year U.S. bond, held to maturity, paid $3,920 in risk-free interest. At the current rate of around 3%, such bonds now pay only $900 in interest. To get the same return now requires investing four and a half times as much money. This increase in savings is unrealistic.

Flat housing prices

Housing is another form of retirement savings, with some retirees buying smaller houses or taking reverse mortgages and using the proceeds for retirement. Over the past 10 years, however, housing prices have been basically flat, with the gains of the housing bubble erased in the crash. Without significant inflation, it’s unlikely that young savers will see large gains on their homes. They will probably see price growth closer to the general inflation rate.

Lower wages, lower savings

Young people are working in an economy in which the percentage of national income going to wages is at a 50-year low. Workers are producing more, but being paid a shrinking share of their production.

The average U.S. gross domestic product (GDP) per worker is $68,374, according to the World Bank. For producing $68,374 worth of value, workers are paid on average $28,717 (42% of GDP produced). In the period from the 1950s to the 1970s, wages accounted for about 50% of GDP. That would translate to an average wage today of $34,187.

In real terms, this is a decline of about 16%. It represents about $5,470 per year in additional income not being paid to the average worker, or about $2.63 per hour. If you could save an additional $5,470 a year over a 40-year career and earn a historically reasonable 6% annual return, you’d end up with nearly $900,000 extra for retirement income.

College debt slows savings

State-supported college education allowed many of today’s retirees to pay for their college tuition with a summer job. This is all but impossible now. Decreasing state support of higher education means higher tuition.

Higher costs mean more debt. The average college student with education debt now has $26,600 worth of it, according to the Project on Student Debt.

At 6% interest, $26,600 requires a 10-year payback of $285 per month, which is $285 of “savings” that young people can’t put toward retirement.

Investing the same amount in an individual retirement account (IRA) at a 6% annual return, a student saver would accumulate more than $49,000 in 10 years. This amount compounded to age 65 grows to more than $461,000 in retirement savings.

Social insecurity

The current political mood leans toward decreasing Social Security benefits. There is talk of a higher retirement age or a recalculation of inflation adjustments. Neither side of the political spectrum is talking about expanding benefits.

Added together, these circumstances create a rocky road for today’s young worker. The hurdles of flat housing prices, low interest rates, declining wage participation, student loan debt, and declining Social Security benefits ensure today’s youth will not enjoy the type of retirement their parents have.

Image via iStock.


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