Falling Short of Retirement Income Needs
A new study by Hewitt Associates found that four out of five Americans need to step up their retirement savings habits or plan to retire at a later age.
Before I go into detail about this study, I have to say that this is alarming and unacceptable. There is no excuse to not be informed about financial basics, and this study further warrants increased financial education.
According to the study by Hewitt Associates, employees will need approximately 15.7 times their final pay to retire when factoring in inflation and postretirement medical costs. This means that if your final salary before you retired was $100,000, you will need atleast $1,570,000 in retirement savings. Many people likely will find this target tough after having seen their retirement accounts decrease so much over the past two years.
Hewitt Associates has broken down the 15.7 times final pay into two components. First, 4.7 of the 15.7 is estimated to come from Social Security, leaving us to cover the remaining 11 times pay. Employees will have to come up with this 11 times pay through company-provided plans (401ks, IRAs, SEPs, etc) and personal savings. In addition, Hewitt found that of more than 2 million employees at 84 large U.S. companies, only 18% of them would meet this goal.
Their study claims that employees are projected to accumulate 13.3 times their final pay w/ Social Security, leaving a 2.4 times pay shortfall. However, if this were me, I would assume that Social Security will not be around. The only person/entity who will take care of you is YOU. To me, the short fall is 6.9 times pay (2.4 estimated + 4.7 from Social Security).
Hewitt recommends three steps for us to take in order to prevent this shortfall:
1. Start Savings
2. Regularly increase contribution rate
3. Work longer
Most people they found that setup retirement accounts at 3% contributions would stay at that level for 3 years or more because they would stop increasing contribution once they reached their company’s maximum match level. For most, that means stopping at 6% (3% from employees + 3% company match). Most financial experts call for a contribution level that is at double digits.
My take on all this is that we will all be working longer, and we all should regularly increase our contribution rates. I’ve actually done this twice this year. First to the level to get the match and second to bring my contribution just under double digits. I think more of us should setup an auto-escalation objective where every year we increase our contribution level until the point we are maximizing out our retirement accounts.
What steps do you think people should take to cover financial shortfalls in retirement, and what have you taken to make sure you will be ready for retirement?
To get more information about the study visit here.
For free resources to help you make sound financial decisions regardless of what stage of your life you are in please visit the 360 Degree of Financial Literacy by the American Institute of CPAs. This is a great free resource to help you get your finances in order, no matter how young or old you are.
What the Hewitt Associates study fails to take into consideration, unless I missed it, is the affect that future taxes will have on retirement savings. For the past twenty years, the top Marginal Tax Rate has ranged from a mere 31%, to as high as 39.6%. As recently as 1980, the rates went as high as 70%, or double that of today. For more on historical rates, check out this link: http://www.taxfoundation.org/files/fed_individual_rate_history-20091231.pdf
Like its constituents, our government has been on a fairly unabated spending spree for quite some time. In order to meet its future obligations, it’s going to have to get those dollars from somewhere. One of those places will be through taxation. I suggest that our marginal tax rates are going higher, much higher. Even as folks are diligently saving in IRA’s, and employer sponsored plans, they should expect to be paying a much higher tax rate, than they are today. This further compounds the issue, of how much we should be saving.
While there are many future events that are out of our control, including stock market fluctuation, and higher tax rates, there are other things people should be doing during our working years to mitigate the risk of a retirement income shortfall. The list includes living on less than they make, and methodically paying off all debts and obligations. Mortgages, auto loans, and credit card payments can increase a persons retirement income need by thousands of dollars a month. All things being equal, the net effect of eliminating debt can potentially decrease your required nest egg by hundreds of thousands of dollars.