We are on the precipice of the greatest retirement crisis in the history of the world. In the decades to come, we will witness millions of elderly Americans, the Baby Boomers and others, slipping into poverty. Too frail to work, too poor to retire will become the “new normal” for many elderly Americans.
That dire prediction, which I wrote two years ago, is already coming true. Our national demographics, coupled with indisputable glaringly insufficient retirement savings and human physiology, suggest that a catastrophic outcome for at least a significant percentage of our elderly population is inevitable. With the average 401(k) balance for 65 year olds estimated at $25,000 by independent experts – $100,000 if you believe the retirement planning industry - the decades many elders will spend in forced or elected “retirement” will be grim.
How much should people really be saving?
More. Far more. Many people are still assuming that they'll get 10 percent annual returns on their savings; the stock market volatility of recent years would suggest that's overly optimistic. To provide for a retirement lasting 20 years, Vanguard, a major 401(k) administrator, now recommends an annual contribution of 12 to 15 percent of income, including an employer's match. But even that is only enough if you start young: A worker who starts contributing at 35 and earns $43,000 has to sock away more than $10,000 a year, the Center for Retirement Research estimates, to maintain his or her lifestyle after retiring at 65. The Employee Benefit Research Institute says the average earner will need $900,000 upon retirement — a sum few people are on target to reach.
Skimming off the top
Future retirees don't have only themselves to blame for paltry retirement savings. Excessive management fees also play a role. Every day, Americans pay about $164 million in 401(k) fees to the financial industry. "There are enormous dollar amounts involved," said Frank Cirullo, a former plan consultant. "Employees are getting ripped off." Fees vary from plan to plan, and can run anywhere from 0.5 to 2 percent of assets per year. An extra 0.5 percent annual fee can cut an employee's savings by 10 percent by the time he's 65, according to Vanguard. Most 401(k) fees have long been hidden, but under new rules taking effect this summer, plan providers have to give detailed breakdowns of all the fees to employers, who in turn have to inform employees. Savers can only hope that transparency kicks off competition that will lower fees.
Save 18 percent. That's the savings rate a medium-earner ($43,084 in 2010) would need if he or she starts saving at age 35 and plans to retire at age 68 (assuming a 4 percent return on investments), according to the Boston College's Center for Retirement Research. The Center issued a brief that provides savings rates need based on a variety of factors, including retirement age, rate of return, income, and age that contributions begin. (The savings rates would allow retirees to replace 80 percent of their working salaries and calculations factor in Social Security income.) The Employee Benefit Research Institute reports that on average, employees contribute just 7.5 percent of their income into their retirement accounts.
The analysis found that the two most important factors for creating a retirement nest egg are one's savings rate and the age of retirement. "If people could work until they're 70, they would have a much higher chance of having a secure retirement. Social Security is higher if you wait until age 70, and it gives your 401(k) assets a longer chance to grow, and it reduces the number of years you have to support yourself," says Alicia Munnell, the center's director. Less important was the rate of return earned on investments.
Simple Targets for a Retirement Nest Egg
So how much money do you need to retire comfortably? People want a neat and tidy number or formula; unfortunately, not much in life is neat and tidy, particularly when it comes to retirement planning.
If you're thinking about retiring soon, at the very least, you should get into the ballpark with respect to how much retirement savings you'll need. The simplest way is to use some rough rules of thumb. Suppose you need a given amount of annual retirement income to supplement Social Security, pensions, and wages (if you work in your retirement years). To estimate the retirement savings needed to generate this income, multiply your required annual income by:
- 20 if you're retiring in your mid to late 60s or later
- 25 if you're retiring in your late 50s or early 60s
- 33 if you want to be virtually certain you don't outlive your assets and you want to leave money to children or charities when you're gone
For instance, suppose you need to generate a pre-tax annual retirement income of $20,000, in addition to your other retirement income. You'll need retirement savings of:
- $400,000 using the 20 multiplier
- $500,000 using the 25 multiplier
- $660,000 using the 33 multiplier
DYI Comments: No doubt planning for retirement is an arduous task along with implementing your plan. I have found that using so called professionals will run from top notch to an almost know nothing. So it is best to become as educated as possible. Sounds so simple yet so few will take the time or the effort. Let's take a look at the last example of 20 times income ($20,000) or $400,000 nest egg for retirement.
Using
TimeValue.com calculator plugging in an after inflation conservative return of 4% what dollar amount per month is needed to amass $400,000. Assuming he or she gets serious about retirement age 35 and then retires after 30 years.
$576. dollars per month seems very doable. At $25,000 income that is 28% of their income! Better hope for lots of pay raises.
At $50,000 income it will be 14% of their income. A big piece of one's income but very doable.
You can play around with the numbers however I would not advise going higher than an after inflation return (and fees) of 6%. You could very easily come up short.
Want to know if you are on track use a
present value calculator? Staying with the same example of a required nest egg of $400,000. Suppose our 40 year now has $100,000 in retirement savings. He needs $300,000 more to make his goal. With 25 years to go and sticking with our after fee/inflation return of 4% his pension is underfunded by $12,535. He will need to boost up his percentage amount of savings. This can be calculated by going back to the monthly savings goal and adjusting his required savings.
For most folks retirement will be not be a depicted on TV as a life of leisure, travel, fine dining etc; it will be nervous at best financially and for many very scary. The biggest fear an elderly person has is running out of money.
Not yet convinced that failure is baked into the voluntary, self-directed, commercially run retirement plans system? Consider what would have to happen for it to work for you. First, figure out when you and your spouse will be laid off or be too sick to work. Second, figure out when you will die. Third, understand that you need to save 7 percent of every dollar you earn. (Didn’t start doing that when you were 25 and you are 55 now? Just save 30 percent of every dollar.) Fourth, earn at least 3 percent above inflation on your investments, every year. (Easy. Just find the best funds for the lowest price and have them optimally allocated.) Fifth, do not withdraw any funds when you lose your job, have a health problem, get divorced, buy a house or send a kid to college. Sixth, time your retirement account withdrawals so the last cent is spent the day you die.
DYI Continues: Not a very happy note to end on but if you are reading this blog then you are light years ahead of the average person.
DYI
