Sunday, October 12, 2008

Due Process

The recent market tumult has hit Main Street in its retirement pocketbook—and some are once again fretting about their “201(k)s.” You can say all you want that this is a good buying opportunity, but the reality is that our retirement savings accounts have taken a hit, and most people are going to be in mourning, at least for a time.

Regardless of the markets (which we can’t control), we all know that the most important determinant of retirement security is how much we save—something we can, within bounds, control. However, when it comes to saving, there are two big questions looming over us, IMHO: Are we saving enough?—and, more importantly, Can we save enough?

Those of the opinion that Americans are saving enough are few and far between. With a median retirement savings plan balance of less than $125,000 (and that was before the impact of the last several weeks), it’s hard to see how we could be saving “enough” based on historical spending patterns, much less taking into account the projected increases in longevity and health-care costs.

The answer to the second question exposes the Achilles’ heel of the voluntary savings system. For most of us, saving for retirement remains one of those things we do after we pay for food, mortgage, gasoline, and even the kid’s braces. That’s not necessarily an irresponsible approach, IMHO, though it can be. The problem, of course, is that most household budgets get divided into things that have to be paid, those that have to be paid eventually, and what’s left over after you have dealt with the former two. Frequently, retirement savings still slips into the last group—for while we often give lip service to the need to “pay yourself,” most people still see it as saving toward something you’d like to have one day, not a bill that has to be paid.

How Much Is Enough?

But, to the point: If retirement savings was a bill, how big would it be? That’s the $64,000 question—and, unfortunately, there tends to be some disparity depending on who you ask and the assumptions you employ. However, if you assume a need to replace roughly 70% of pre-retirement income (and that number is too low, by some accounts), and if you assume that you are looking at a 30-year-old employee who makes $50,000, a recent Vanguard study puts that annual savings rate at 17% of pay—per year. Even if the worker makes no more than $25,000, the deferral rate would need to be 14%. There is disagreement on the amount that needs to be replaced, though 70% is about as low as any credible source still goes. The bottom line—what’s likely to be required is likely more, perhaps much more, than anybody you work with is currently saving.

Can—or will—workers save at that rate? Well, some are already close to that, certainly once you factor in an employer match. But again, those rates of saving “work” only if you start early—and, of course, if you are “only” trying to replace about 70%. If you think you’ll need more—or if you start later—or if you are trying to replace a higher income—you’d need to save more, or hope for other sources of income.

What does that mean for the future of retirement? Well, for those still in the workforce—and certainly for those on the “wee” side of 55—I suspect retirement will start later, and perhaps start differently, than it has for today’s retirees. Some will try to stay in the workplace longer (let’s face it, you won’t even get full Social Security benefits today if you retire at 65), though they may look for ways to cut back or “phase down” ahead of full retirement.

This actually works out to be a powerful savings strategy. I have seen any number of studies that suggest that working till 70—continuing to add to your nest egg—while at the same time forestalling tapping into it for another five years can transform many (most?) of those projections of inadequate savings accumulations into sufficiency (you can see this on just about any retirement projection calculator as well).

Want “Adds?”

On the other hand, it’s one thing to want to work longer (“want” perhaps not being the best word to describe that decision), and perhaps another altogether to have that option. Indeed, statistics suggest that workers routinely depart the workforce prior to their 65th birthday, and frequently not of their own volition (and not because they have achieved the requisite level of retirement income security). Consequently, while working longer may be part of the plan, you can’t afford (no pun intended) to simply expect that will be an option.

These past several weeks, much has been said about the economic crisis foisted on the “rest of us” by those who promised a free lunch to others who were willing to be duped, or were at least willing to be led to believe (of course, some drew that conclusion on their own) that what couldn’t be afforded now would be available at more favorable terms in the future. $700 billion later (before add-ons), we’re not even sure who we’re “helping.”

It’s not too much of a stretch to see a similar pattern emerge in retirement savings. There are plenty of folks who, rather than make a tough choice today, have chosen to put off the day of reckoning. They’re hoping for a time when it will be easier to save for retirement, a time when it will be more affordable—and some, no doubt, are simply hoping that someone else will solve the problem for them. And yes, some got rich while fostering those illusions.

Like it or not, retirement savings is a bill. It may look like “no money down” today, but there’s one heck of a balloon payment coming.

- Nevin E. Adams, JD

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