3/1/2011 6:54 PM ET|
Boomers find 401k plans fall short
Big gaps exist between savings and what Americans need to support themselves in retirement. Many started saving too late, and the financial crisis has made thing worse.
The 401k generation is beginning to retire, and it isn't a pretty sight.
The retirement savings plans that many baby boomers thought would see them through old age are falling short in many cases.
The median household headed by a person aged 60 to 62 with a 401k account has less than one-quarter of what it would need in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve and analyzed by the Center for Retirement Research (CRR) at Boston College for The Wall Street Journal. Even counting Social Security and any pensions or other savings, most 401k participants appear to have insufficient savings.
Data from other sources also show big gaps between savings and what people need, and the financial crisis has made things worse.
This analysis uses estimates of 401k balances from the end of 2010 and of salaries from 2009. It assumes people need 85% of their working income after they retire in order to maintain their standard of living, a common yardstick.
Facing shortfalls, many people are postponing retirement, moving to cheaper housing, buying less expensive food, cutting back on travel, taking bigger risks with their investments and making other sacrifices they never imagined.
"Inevitably, we find that, for the average person, there is not enough there," says financial adviser Paul Merritt of NTrust Wealth Management in Virginia Beach, Va., who has found himself advising many retirement-age people with too little savings. "The discussion turns out to be: What kind of part-time work do you want to do after you retire?"
He has clients contemplating part-time work into their 70s, he says.
Tax-deferred 401k retirement accounts came into wide use in the 1980s, making baby boomers trying to retire now among the first to rely heavily on them.
The problems are widespread, especially among middle-income earners.
About 60% of households nearing retirement age have 401k-type accounts, according to government data, and those represent the majority of most people's savings.
The situation is less dire for those in a higher income bracket, who tend to save more outside their 401k accounts and who have more wiggle room if their retirement returns fall below the recommended 85% replacement level.
Steven Rutschmann, 60, manages the buildings and grounds at a research facility in the Midwest. His employer recently offered him a bonus if he retired early.
Rutschmann's 401k is well into six figures. His wife also has a 401k and expects a small pension from her nursing job. An outdoorsman, Rutschmann dreams of spending time hunting, fishing and hiking.
So he consulted a financial planner at Ernst & Young and learned that even with the bonus, his savings could run out before he turns 85. Now he expects to work for several more years.
"I was disappointed," says Rutschmann, whose 401k balance was damaged by the financial crisis and who still has a large mortgage.
In general, people facing problems today got too little advice, or bad advice. They didn't realize that a 6% annual contribution, with a 3% company match, might not be enough.
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Yours is how most peoples' stories should read if they want to retire well. It is unrealistic to think anything else.
People who think that everyone should be able to live 80+ years and only work 30 of them need to ask themselves "Who is going to produce what we need to live on?". In the large picture, the answer is that we need to produce and save enough in those 30 years so that there is enough for us to live on our entire lives. Those who live "paycheck to paycheck" had better expect to be earning paychecks all their lives.
Social Security should be counted as a money market account when investing. Its low risk and cost of living increases make a perfect base of 35% or 1/3rd of what you will need.
The 401K invested in the company offered accounts should be balanced with 60% stocks and 40% bonds to reduce the overall volatility and this mix can be carried into retirement. These funds can be from 30% to 50% of your needed retirement income.
The IRA has 2 options. The regular or traditional IRA that allows for a tax deduction when you are contributing into it is recommended for those in the 28% or more tax bracket on their earnings and the Roth IRA for those in the 15% or less tax bracket who wish to stay in that lower tax bracket when they retire. The IRA is the self directed portion of your retirement money that you will need growth in to cover inflation and should be invested in dividend paying equities (stocks) . This is where you make up for lost time in your previous years of investing and can count for as much as 35% of your retirement income.
The Variable Annuity, offered by most life insurance companies is also a catch up option. Having the same rules as the IRA except for the Maximum annual contribution limits, it can also allow you to build up retirement savings in the stock market or other investments but its expense ratio is so high, you would need top use this vehicle for the most risky types of equity investments to stay ahead of inflation. Some of these programs also have a 5% guaranteed life insurance growth rider that adds 5% to your investments per year on the Life insurance portion so if you were to die before you retired or just shortly after retiring, your family would receive an annuity or cash settlement greater than the fund you invested. Use this investment vehicle only when all the others are maxed out for the year and you wish to invest more while you can afford it, like a bonus or inheritance.
Social Security takes about 12% of your income in premiums 6% from you and 6% from your employer.
The 401K may be 8% to 12% depending on the employer contribution.
The IRA could be around 5% to 8% of your earnings and the Variable Annuity 3% to 5 %.
These numbers add up to 28% of your income at the low end and 37% on the high end. If you don't count the 12% going into your social security, you need to be contributing 16% to 25% of your wages or salary into your retirement in order to live out your life in real comfort.
I retired at age 55 nine years ago and have yet to touch my IRA or Variable Annuities because so far my 401K, Social Security and traditional pension have been adequate. I contributed close to 25% of my income into those plans listed. Most of the investments went into "Dodge and Cox Balanced Fund" through my employer/union selection plus my 12% Social Security so I know the figures I have given work. I contributed into them from 1981 until I retired on March 1, 2002 . 20 years of 25% contribution made it happen. Good luck.
Notice how this is worded to imply the fault lies in the 401K rather than in the individuals who have CHOSEN to spend money now rather than later.
And don't tell me how people don't have enough income to save any. I have relatives on welfare and they spend up to $100 a month for TV cable (and add-ons), and this is just one example. People have no idea what is necessary vs. their wants--what is actually required for living. And behind all this are choices as teenagers and young adults to denigrate education and reason. These kinds of choices keep people impoverished, not 401Ks or any other external reason.
Also the big numbers for what's required to retire are inflated by the idea that you must keep up with inflation, and have the same relative income at 85 that you have at 65. This is nonsense--what you'll feel like doing at 85 will be much less than at 65, and your money needs will declilne along with the effect of inflation.
For the 30 somethings today, the key words are priorities and foresight. You must become financially educated and literate.
He with the most toys doesn't 'win' because he's probably broke.
Have any one gone through the calculations? Assuming that your total annual salary is now $60,000, and that your annual retirement income should be 85% as most "financial advisors" say it should be at retirement, you should then retire on $51,000 to keep your "same standard of living", that means that you should find a place where you can park your money with a payout of 5% annual interest (this days that animal does not exists), provided that you were lucky enough to have savings of 1 million+!!! Yeah the magic of compounding will do the trick, and most pundits assume a 12% rate of return, assume that you can save young (when you probably are paying college debt, has just got married, have children, and a mortgage to top it all), but the true market rate of return for the last 20 years have only been 7.5% (or thereabouts).
Now you are giving the government 7.5% of your salary, your employer is also giving the government 7.5% (that is Social Security taxes), total 15% yearly, and now the government turns around and calls that an "entitlement", and say that it has to be cut, come on!! An not only that, the same government uses that money interest free (yeah China gets interest on its government bonds, thank you), and gives you and IOU, and then turns around and says that it ain't paying!! If you retire at 65, with a $60K salary, SS pay you a paltry $19K a year. Had you invested that money for 30 years, assuming a $50k salary, and a 7.5% annual return, you would now have $775K, which at 7.5% would earn you $58k, enough to cover your retirement!!!
The contributions saved in the plans fell short.
If during your mid to late working life you are regularly drinking $60 bottles of wine, buying or building a big new house, keeping all or most of your 401K in stock - all while contributing 10% or less into the plan, with no clear grasp of retirement funding needs - yes, you're going to be in deep trouble. Pretty much guaranteed.
The math over the years has never changed. If you need, say, $30,000 annually in retirement income to supplement social security, that's never NOT required having in the neighborhood of $800,000 saved by retirement - after inflation, and after inevitable market ups and downs.
This is the first generation to live well past 65, AND not have substantial pensions, AND not have bothered to save much, AND have unrealistic lifestyle expecations. It's a bad combination, and apparently the train wreck is now playing out. If you're under 40, there's a lot to be learned from this about how to handle your finances in the next few decades.
"I live in New Jersey and my biggest expense is property taxes"
Dan, I know what you mean.
I was fortunate enough to get a job transfer and move from NJ to Virginia 15 years ago. I bought roughly the same size house on the same sized lot, two car garage, four bedrooms, roughly the same age. My property taxes today, are still slightly less then 50% of what I was paying, in NJ, 15 years ago!
And yes, we have paved roads, city sewer, curbside garbage pickup, new schools (to educate all the children moving in from higher taxed areas).
The problem in many (if not most) of these cases is people not being proactive enough in managing their money. One of the most basic principles of investment is to steadily reduce your exposure to equities as you get closer to needing to rely on your investments for income. Doing so would have greatly mitigated some of the horrific losses documented in this article. Of course, if you are not contributing enough to begin with, I suppose you have to gamble on equities late in life, but to me that is roughly the equivalent of buying lottery tickets as your retirement plan.
This will hopefully serve as a harsh wakeup call to younger people regarding the critical importance of contributing properly to their retirement savings and staying on top of their investment mix.
I live in New Jersey and my biggest expense is property taxes, and the government simply will not stop spending money they do not have. They just will continue to tax and spend. I will have to leave the state, even if I have to give my house away.
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