Saving more money ranks up there just behind losing weight as a leading New Year’s resolution for Americans each January. As a nation, we seem to struggle to achieve either goal. As an incentive to setting and reaching the savings objective, I recommend a just-published book, Falling Short: The Coming Retirement Crisis and What to Do About It.* This well-researched, lucidly written, slender volume describes in detail the growing dilemma of financing retirement and provides advice on how to rise to the challenge.
The book begins by reminding us that, “Just 30 years ago, most American workers were able to stop working in their early sixties and enjoy a long and comfortable retirement.” This golden age is over due to a combination of factors: people are living longer; defined-benefit pensions provided by employers have been replaced by 401 (k) type defined-contribution plans with (typically) modest balances; the income replacement rate from Social Security is steadily declining; and health-care spending in retirement is rising.
The Challenge
The authors calculate that even today, less than half of Americans are financially prepared for retirement at age 65 (and less than one-third at 62), defined as able to replace 75% of final salary and maintain a pre-retirement standard of living. Yet the average retirement age for men is 64 (a year less than it was in the 1960s, when the life expectancy was much shorter) and 62 for women. Thus, people today on average will live at least 20 years in retirement, compared to 13 years in the 1960s, and with less income help from the government and employers (the Social Security Administration reports that, on average, a 65-year male will live to 84.3 and a female to 86.6, and that a quarter of 65-year-olds will live past 90).
Under current law, income replacement rates from Social Security will be much lower than those enjoyed by our parents—falling from 40% in 1985 to 31% by 2030 (and only 24% for maximum earners) for a variety of reasons, such as increases in the “full retirement age”; more retirees paying taxes on Social Security checks; and increasing Medicare premiums, which take a bigger bite out of benefit checks (and this analysis assumes continued fiscal health of the Social Security program, which is probably a heroic assumption and one extensively discussed by the authors).
In recent decades, company pensions, where employers were essentially responsible for making saving and investment decisions on behalf of employees, have gone the way of the dodo bird. Most employers have also stopped providing post-retirement healthcare benefits. Defined contribution plans for employees such as the 401(k), originally designed to supplement company pensions, are not well funded enough to pick up the slack—only about 10% of participants contribute as much as allowed in their 401(k) plans and the average household nearing retirement has only $111,000 of retirement money, enough for only $400 a month of income in retirement.
Save More, Start Earlier
From these facts of life, the authors conclude that, unless Americans want to be poor in retirement, they need to save more while working (sorry, that requires reduced spending, including for high earners, for whom the social security replacement rate is relatively low) and/or work longer, which implies fewer years in retirement (Source: Falling Short). The matrix below provides the authors’ calculation of the implications of different saving rates and retirement ages (for our research on portfolio withdrawal rates, see Investment Strategy: What’s a Sustainable Portfolio Withdrawal Rate?).
Most Americans need to sock more savings away in 401(k) and other retirement savings accounts, which may require altering behavior and possibly working with a good financial advisor. “Because we lack discipline,” contends Falling Short, “we need devices that force us to put money aside…Experience shows that making saving easy and automatic is the only way to make it happen.” And we need to start saving from a younger age— starting to save at age 25 instead of 45 cuts annual required savings by two-thirds, according to the authors’ sums.
Those savings also need to be invested much more productively—the authors calculate that adverse investor behavior (e.g., selling stocks after market declines and buying stocks after market rises) cuts the average investor’s long-term return by one-third (we have also studied the important issue of investor behavior and returns:
70 is the New 65
Unless there is a miraculous increase in the saving rate, many people will need to work until 70, conclude the authors, who calculate that today 85% of people can afford to retire at 70 (vs. 50% at 65). Extending work life confers many financial benefits: it allows for more contributions to retirement savings, produces current income, increases monthly Social Security benefits (which can also increase the survivor’s benefit), and shortens the period of withdrawal in retirement. The authors figure that delaying the retirement age from 62 to 70 also reduces the required annual saving rate by two-thirds.
In fact, the book asserts, 70 is already Social Security’s real retirement age, since benefits are reduced actuarially for each year claimed before that. The authors say that the government should deliver a wake-up call to its citizens by announcing that 70 is the new 65. “Social Security’s real retirement age,” they argue, “is the best-kept secret in town.”
*Falling Short: The Coming Retirement Crisis and What to Do About It, by Charles D. Ellis, Alicia H. Munnell, and Andrew D. Eschtruth, Oxford University Press, 2014
First published on Gerstein Fisher Viewpoints Blog
Follow us on Twitter - @GersteinFisher
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Gerstein Fisher), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. All references to market performance was obtained from
Bloomberg
database. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Gerstein Fisher. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Gerstein Fisher is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Gerstein Fisher’s current written disclosure statement discussing our advisory services and fees is available for review upon request.
