One of the biggest financial changes over the last generation has been the assumption of retirement savings risk by individuals. A generation ago, many workers in both the private and public sectors had defined benefit plans that were quite generous. (As we are finding out, the public pension plans were so generous that they are now bankrupting states, counties, and municipalities.) Even the private corporate pension plans had great benefits—often nice payouts along with retiree healthcare.
As automation and productivity increased, fewer workers were needed to reach the same production level and corporations found themselves with fewer current employees trying to support a large base of retirees. This is the same demographic situation that plans like Social Security find themselves in, by the way. The cost pressures became unbearable, especially if the corporations intended to survive in an increasingly competitive global economy.
Corporations looked for ways to shift the retirement cost burden and over the past generation have moved to defined contribution plans, most often 401k and profit-sharing plans. With a 401k plan, much of the onus of saving is shifted to the employee, although many of the best employers have excellent matching programs.
Alicia Munnell, the director of the Center for Retirement Research, recently penned an article in Smart Money that lays bare how Americans are doing on the path to retirement. She writes:
In theory, a typical worker who ends up at retirement with earnings of slightly more than $50,000 and who contributed 6 percent steadily with an employer match of 3 percent should have about $320,000.
In fact, the typical individual approaching retirement had only $78,000, far short of the simulated amount.
She pulls data from a number of other sources to support the $78,000 number as realistic, but whatever the actual number, it is clearly far short of $320,000. The amounts Americans have saved will produce a very meager retirement.
Using the SCF [Federal Reserve Survey of Consumer Finances] figure of $78,000, 401(k) balances will produce about $400 per month of income in retirement if the participant buys a joint-and-survivor annuity; $260 per month if the participant applies the “4-percent” rule.
$400 per month, even with some kind of Social Security benefit, is still going to put a lot of retirees squarely into the Alpo zone. And you’ve got to hope that the Social Security benefits will still be intact.
This is not an outcome that is good for anybody. It’s not good for the retiree who is trying to eke out an existence on an insufficient level of income. And it’s not good for responsible savers who do have adequate assets—that’s the first place the government will look for money to redistribute.
What can you do to help your clients avoid this problem? As with most simple problems, the solution is fairly simple too.
1) Save more. 6%, as in the example, is probably not enough. Most experts recommend a minimum of 10% of your income be saved. I’d go for 15%. It would not be tragic if I had too much money saved for retirement and had to work down my balance by taking Mediterranean cruises, for example.
2) Invest for growth. You might have to embrace a little risk, but the ultimate payoff may be well worth it. Higher investment returns compounded over a long period of time can make a huge difference. (Hint: relative strength is an excellent return factor for growth.)
3) As you near the withdrawal phase, transition to a less volatile portfolio mix. Studies show that less volatile mixes provide steady income for a longer period of time.
None of this is new—the same policy prescription was advocated in Andy’s Short Course in Financial Planning way back in 2007, before the financial crisis was a gleam in Ben Bernanke’s eye. And eternal truths don’t change. Get your clients on the right track, and push to keep them there.