2011 February 20 Sunday
Americans Not Saving Enough For Retirement
Odds are you probably are not saving enough for retirement and will have to work into your late 60s and beyond. (very worth a read)
The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed 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 at Boston College for The Wall Street Journal. Even counting Social Security and any pensions or other savings, most 401(k) 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.
A typical couple needs about $650k in a 401(k) going into retirement to maintain something close to their working living standard. The article includes anecdotal reports of couples shocked to find in their early 60s that they have to work five or ten more years. What's worse? People who retire in their 60s without doing due diligence to figure out how long their cash will last. They'll be living in hovels and eating really cheap food by the time they die.
Put away 15% of your salary per year. Even this estimate sounds too low to me.
Vanguard Group, one of the biggest providers of 401 (k) plans, has changed its advice on how much people should save. Vanguard long advised people to put 9% to 12% of their salaries—including the employer contribution—in their 401(k) plans. The current median amount that people contribute is 9%, counting the employer contribution, Vanguard says.
Recently, Vanguard has begun urging people to contribute 12% to 15%, including the employer contribution, because of the stock market's weak returns and uncertainty about the future of Social Security and Medicare.
Note that Vanguard sees uncertainty around the future of Social Security and Medicare. Well, Barack Obama just proposed a budget with a $1.6 trillion deficit. Uncertainty? No way. I am quite certain that Social Security and Medicare benefits will be cut, along with many other programs. The US government can not pursue fiscal insanity indefinitely. Eventually the market will discipline the USG and force Congress and likely the next US president to cut, cut, cut. California and Ireland serve as models of what is to come. Chop, chop, chop.
Your real savings needs exceed even what this Wall Street Journal reports because the stock market is not going to provide the kinds of returns that it has for most of the post-WWII period. Combine the arguments in Tyler Cowen's arguments for why raising living standards has gotten harder (see The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History,Got Sick, and Will (Eventually) Feel Better) with the approach of Peak Oil and America's declining demographics and what do you get? The US economy (as well as other Western economies) looks more likely to contract than grow over the next 15 years. Think technology is going to save us? American technology companies generate very few jobs for American workers.
Is that 20% before or after taxes? I mean, I (just) make 100k, but I only realize about 60 of that after taxes and health insurance. The mortgage for my extremely modest house is 2k a month...24k a year. So that leaves me with 36k a year to buy groceries, gas, etc... If you are telling me I need to sock away 20k a year if I hope to retire, that means I need to raise a family on 16k a year. So my choice is to either beggar myself now or beggar my future self. Sorry old dad, you lose.
The article says a retired couple "need" 74k annual income. Median family income in the US is 50k. Why does a couple with no commuting or childcare expenses and a house that is paid for need more income then the average family? Journalists are poor with numbers.
It is scary how much one needs to make to assure oneself for one's whole life what used to be thought of as a middle class living standard.
A few points:
1) They probably mean before taxes.
2) If you put money into a 401(k) you do it with pre-tax dollars. So if you put away a dollar you probably (depending on what state you live in) only lose 55 to 60 cents depending on your marginal tax rate.
3) At least you are building up equity in the house. That's good.
4) When the kids leave home you are going to need to sock away a larger fraction of your income.
5) How much you need to sock away per year depends on how old you are and how much you've socked away so far.
6) It would obviously help if you could find a way to raise your income or found an employer who offers a higher 401(k) match.
I think their assumption is what does it take to maintain a comparable standard of living post-retirement. Yes, $74k is a lot more than the average person makes.
Keep in mind that if old folks start paying a larger fraction of their total health care costs (which seems likely for all but the poorest) then their cost of living could be higher in retirement. The inflation rate for health care is much higher than the inflation rate for most other goods and services.
In some ways the "maintain something close to your working standard of living" is deceptive as individuals in retirement have significantly lower costs than workers. Commuting costs, personal expenses incurred during business travel that are not reimbursable. If you 'working standard of living' includes paying a mortgage on one or more homes an opportunity to cut costs is selling and buying a place for the proceeds and eliminate the mortgage.
The big problem for many booomers facing retirement is not that they haven't saved enough to maintain their working life style, its that they don't have enough to barely keep them above the poverty line. IIRC the average boomer household has retirement savings of only $125,000.
Well, this is literally what I do for a living. I'm a fee-only financial advisor. The fee-only part means that I'm one of the good guys. I also used to be a reporter, so I know how bad those guys are with numbers.
While I'd agree that overall, the majority of baby boomers are seriously screwed, I'm not sure that article (or what I read of it) got everything quite right. Most importantly, people do have other accounts besides 401ks. Most people nearing retirement have IRAs and, at times, brokerage accounts, so looking at 401k only may skew the result. But the results probably aren't too far off.
But I'd argue that on top of their lack of savings, boomers are going to be severely screwed because they don't have a clue on how to invest what little they have. It's a lock that they'll earn seriously sub-par returns on their portfolios due to their own ineptitude or because they use terrible, expensive advisors. Dalbar, an economic consulting firm, does a nice study that they update each year showing people's investment returns in stock and bond funds compared to standard benchmarks like the S&P and Barclays bond index. People get crushed. They barely earn the rate of inflation on their investments.
If you do a good job with your investments in retirement, you could expect 7-8% after-cost long-term annual returns. That means that you could take out 4-5% safely each year and allow the portfolio to grow with inflation. But your average Joe will likely get ~4-5% a year after-costs - if they're lucky. That means that they could take out 1-2% a year safely and allow for inflation growth. So take a guy that needs $75k a year. Maybe he and the wife get $35k in SS (if you're under 50, I'd cut that by a 1/3 to 1/2), so he needs $40k to make up the difference. Even if he's on the upper end of our average Joes, he'll only be able to take out 2%. In that case, he'll need $2 million. Fat chance. He probably has ~$200k, so he'll get a whooping $4,000 a year to supplement SS. Have fun with that.
Of course, our Joe won't do that. He'll take $20k a year, move most of his money into stocks and will get utterly crushed by the next downturn. Basically, one way or the other, he'll be broke by 70. Really, it's not now that we'll see the big problems, but ten years down the line, when the boomers savings runs out.
As to the rest of you, Vanguard is close to right. If your in your 20s, save 13% (10% from you, 3% from employer; if not match, make up the difference yourself); 30s, save ~16%; 40s, save ~20%; 50s, well, you can't do it by saving, you need to cut back now. For the portfolio, put your age (or age minus 10) of your portfolio in bonds (the safest possible, don't go for yield with bonds, they're all about safety so use Treasuries if possible, otherwise AAA corporate), so if you're 30 years old put between 20-30% of portfolio in bonds. With the stock money, use INDEX funds and only INDEX funds. Divide the money among the S&P Index or US Total Stock market index fund (40% of stock money goes here), an International stock index fund (40% of your stock money goes here) and an emerging markets index fund (20% goes here).
Each year - just once a year - rebalance the portfolio back to it's original percentage - NO MATTER WHAT! Each time you age hits a five or a zero (25, 30, 35, etc.) readjust the portfolio to increase the bond allocation and then rebalance. Do that and you'll beat 90+% of your neighbors and 80+% of professional money managers over the long run. Check out books by William Bernstein, Larry Swedroe or the Coffeehouse Investor for a nice short look to learn more about investing.
Also, buy a house eventually, and pay off the mortgage by retirement. If you save like I recommend, use index funds, rebalance and pay off your house, you'll be fine. You'll also be unbelievably uncommon. I'd suspect that less than 1% of the population does these extremely simple but overwhelmingly effective moves.
"Americans Not Saving Enough For Retirement"
Do Americans save? - Have Americans ever saved in the past 50 years? how and when exactly? - before or after they've gotten in debt? - before or after they've paid their debt? - before or after they buy all that worthless junk they have piled up in their garges, including cars?
Americans are not saving enough since WWII, only continue to spend, -and of course invade other lands when running out of wealth-
It's unrealistic to think that the average earner could save enough for retirement. Currently, if you make it to 65, you'll average another 18.5 years. But you can't plan to run out of money at that point, so really, you need to plan to hold out until around 90. So you're going to have to save enough to live another 25 years, and of course you could outlive that. But when you're younger, you'll probably have to save for your kids' education as well. So how the hell are you going to rack up all this money? I understand if you've got two-upper income careers in your household it can be done, but the average person doesn't.
Let's face it, for a lot of people, their retirement plan is going to be an in-law suite in their kid's house. Which is OK, since they can provide the child care and cooking while both members of the next generation are working. Multi-generational households are going to make a comeback, a good reason to undertake the hassle and expensive of having kids. I know I'm going to be expected to have a place in my kid's house if I live long-enough.
When people say that a retired couple who owns their house and has no debt "needs" 74k annual income you have evidence that people have an inflated sense of what you "need" to live. The property taxes, utilities and grocery bills for two people living in a modest house does not come anywhere close to 74k in most of the US. It may cost that much in New York City but outside of the coasts a couple can live comfortably on much less then 74k a year.
'He probably has ~$200k, so he'll get a whooping $4,000 a year to supplement SS. Have fun with that.'
In general your advice is sound (for someone who wants/needs to spend as much in retirement as they did earlier). But in doing these later calculations you're acting as if any and all drawdown of of the base capital must be avoided. Even if someone expects to live for forty more years, they can get quite a bit more than $4K a year from $200K. Not going to bother to do the annuity calculation right now.
Just to follow up on some of the comments. First, I find with my clients that their cost of living doesn't really decrease in retirement. some costs go down - communities, clothing - while other costs go up - medical, vacation, hobbies. However, what I do find is that their internal inflation rate is very low. That's important because you definitely need less retirement money if your spending barely creaps up each year.
Second, someone mentioned that even if people live to be 95, they could still draw down on their retirement money faster that 4-5%. True, except for two issues. First, people usually want to leave some money to their kids. Second, the difference in the amount of money that you can take out of a portfolio using a 5% withdrawal rate compared to just assuming that you'll die at 95 with zero dollars isn't that much, especially when you consider that if you use the 5% withdrawal rate, you can invest some of the money in stocks while the draw down to zero method is so risky that you need to keep almost all or all of the money in long-term bonds. It's not worth risk.
Finally, the figure of $75k is a random one. Someone was right that in many parts of the country, you can live quite well on much less, and thus, SS takes care of most of your needs. However, SS will be reduced and Medicare will be more expensive in the future. Also, let's face it, alot of people live in relatively expensive area. Yes, you could move in retirement to a less expensive area, but that often means leaving family and friends behind, which isn't what many people want for retirement.
Look, there are alot of moving parts to investing and retiring so no broad statement will be perfectly correct. But I know what will work every time: Save at least 12% of your income (see above for more details#; invest in index funds; take the right amount of risk; diversify globally; rebalance your portfolio religiously and pay off your house #if renting, save an additional 5-10% of income#. No matter what your particular situation, do those things and you should be in good shape.
Don't buy the noise about Wall Street being rigged. It is - for day traders. But long-term investors in index funds fly right over that crap. We don't play their games. Over the long run, the market will be correctly valued. And, yes, the market has sucked for 10 years #though a globally diversified portfolio did just fine - check the Coffeehouse Investor site for proof), and, given it's history, it could easily suck for another 5-10 years. Or not. No one knows. That's the point. But sooner or later, you'll get your reward. But you have to be patient and stick with the plan, or I guarantee, you will be eaten by the wolves. No doubt. My clients are fine, and I didn't do anything different that what I've written here and what you can read in the books that I recommended.
It's your choice now.
Great comment Mercer.
It really is amazing when you consider how much we think we need. I believe we have a publicity loaded country. Too much visual and conceputal pollution on television, creators of new "needs" for the people, specially kids.
In 20 years the country will be run by a nasty and incompetent coalition of third-worlders and leftists. You'll be lucky if you can buy a meal with your savings.
I don't think you can estimate the adequacy of individual savings based only on contributions to 401(k# plans. I only contribute enough to my 401#k# to get my maximum company match. The immediate ~60% return on my investment is nice, but the money is basically immobile until I retire, unless I want to take a large tax penalty or take money out as a loan. The rest of my savings goes to my bank or my brokerage account; my mortgage payment, too, is a form of savings. I don't even think of my 401#k) as central to my savings, nor do I really separate "retirement savings" from any other kind, though I do keep tabs on whether I'm on track for an adequate retirement.
Furthermore, retirement for me is ~35 years away and, given our country's massive budget deficit, I'm not convinced that income tax rates will be lower then than they are now. I'd prefer to take the tax hit now. Really, by 2045 I'll be surprised if anyone is paying less than a 25% marginal rate.
Another important form of retirement savings is non-financial: take care of your body. Cardio exercise at least 4 times a week and strength training 2-3 times a week. And take care of your mind by continuing to learn new skills. If you do have to work past 65 (and most people will) you'll need a body and mind prepared to do so. It will also help you better enjoy retirement.
Part of the problem is that these retirement (under)estimates look at how the S&P 500 performed in the past several decades and then simply assume that such growth will continue indefinitely. My own suspicion is that securities markets have grown so rapidly since the late 70's/early 80's compared to the rest of the economy that expectations of future returns from passive investment strategies are probably inflated.
How about thinking a little outside the box.
This idea of saving for retirement so you can sit in your aging empty 4 bedroom house by yourself and take vacations and do stupid hobbies is just freaking weird.
No offense to those of you who dream of such.
I plan to give my kids paid for homes as soon as they marry, so their wives can stay home with the kids, etc. I would be happy to be a penniless ward of the state knowing my boys have what they need to live and set their kids up when they marry.
I am checking into all the ways to transfer all of my wealth to my kids before I am eligible for SS, Medicare, SSI.
My ultimate dream is to spend my old age changing my grandkids diapers, cleaning my kids' bathrooms, doing their laundry and dishes and helping my grandkids with their Calculus and Physics homework. I would get a thrill out getting a SS check that I could cash and give to my kids while I sleep on the sofa and hang my clothes in the hallway coat closet so that my grandkids can flourish in a private school not a socialist indoctrination camp.
Since we have saved far more than the Vanguard group recommends and still have a long way to go, I think I can make my dreams come true.
Vanguard is not an unbiased source of information: they make PROFIT from people putting money into mutual fund accounts.
It's possible to live OK in a place like Florida with just Social Security. No one is going to die in the streets because they don't have half a million dollars saved up.
A few points:
- Medicare and Social Security cuts will happen. The United States is on an unsustainable fiscal path with a budget deficit of about 10% of GDP.
- Peak Oil will make this far worse. We are in danger of a double dip recession due to the oil price spike. Imagine the US going into a recession with already a 10% GDP budget deficit at the federal level. Governments can not use fiscal stimulus. They will have to cut instead.
- The US has other problems that will make current mainstream long term growth projections (on which future budget deficit projections are based) turn out to be excessively optimistic. Therefore average returns on 401(k) accounts will be lower.
- The efficacy of medical treatments will rise. So the value of having cash to pay for them will rise.
- Old folks who develop disabilities (including mental disabilities) need far more than monthly Social Security to pay for their care. I've walked thru the numbers for doing this with friends and family members. Expensive. Amazingly expensive.
" Old folks who develop disabilities (including mental disabilities) need far more than monthly Social Security to pay for their care. I've walked thru the numbers for doing this with friends and family members. Expensive. Amazingly expensive."
Only if you insist that it be done by strangers in a licensed facility. It wasn't always expensive because that work was given to female family members. Dingy, incontinent granny and grampa were taken care of by the women for $0. Why is it so damned expensive to have some idiot immigrant spoon feed, sponge bathe and wipe grandma's drool?
When women had 8 or 10 kids then, yes, there were often enough kids around to take care of grandma and grandpa. But what about modern families with 2 kids or 1 kids or 0 kids? Who takes care of those people?
Worse, people move around and end up hundreds or thousands of miles away from their parents. Often this is due to greater specialization of labor. Software developers end up in Silicon Valley, Seattle, NYC, and DC for example. So parents and kids are nowhere near each other. Florida is a retirement state. People move there to retire while their kids move somewhere else.
Plus, suppose kids are even available. Have you ever seen up close what it is like for a dutiful son to take care of his demented mother? It is not even possible for one or two (also working) people to dot his because mom goes out the door and gets lost in the neighborhood while the kids are at work. I've had friends tell me stories from their own families. So I know this happens.
"Plus, suppose kids are even available. Have you ever seen up close what it is like for a dutiful son to take care of his demented mother? It is not even possible for one or two (also working) people to dot his because mom goes out the door and gets lost in the neighborhood while the kids are at work. I've had friends tell me stories from their own families. So I know this happens."
If grandma is 75, and her daughter is 50 and granddaughter is 20, why is it better for working couples to use their dual incomes to keep their daughter in college studying art and chasing exciting alphas rather than have her home caring for grandma?
Obviously these are not the only scenarios, but the first may well be more common than the second. However the first may be healthier for everyone than the second.
"However the first may be healthier for everyone than the second."
should be "the second may be healthier for everyone than the second."
CFP's advice is on the money, overall. I disagree with the equity allocation, however. I'd put 60-70% in the Total Stock Market Index, 30-40% international. I think CFP's allocation of 20% in emerging markets is too risky, particularly if these investments are in Vanguard. Vanguard's Total International Stock Index contains 25% emerging markets already, so 10-15% in its specialty emerging markets fund would be enough exposure there. Other than that, I agree with CFP.