Here's What Life Will Look Like If You Don't Save Enough

Well, this is timely: in the midst of the debate that’s raging over whether or not people in their twenties should be saving their income for use in the future, JPMorgan just issued the banking-world equivalent of a mic drop.

In a 72-page blockbuster report released Wednesday morning, JPMorgan Asset Management makes the argument that not only should people in their twenties save money, but they should be saving 15% of their income if they want to be prepared for everything life will throw at them.

And for those who think, “what could possibly happen to me?” the report, which is titled "The Millennials," is here to provide a rude awakening.

“What we’re trying to get across in this paper is that, while there may be some advancements in things like the quality of medical care, driverless cars and progress on global carbon emissions, there are other things happening that may present bigger headwinds,” report co-author (and head of JP Morgan’s market and investment strategy) Michael Cembalest told FORBES in an exclusive interview.  “The risks don’t come from the inside, but the outside.”

In other words: you can control how much you save, but you can’t control what will happen to you as you age. And the odds are high that something adverse will happen. Consider, for example, this stat from the Center for Retirement Research at Boston College: “ Over any 10-year period, more than three-quarters of adults aged 50-60 experienced job layoffs, widowhood, divorce, new health problems, or the onset of frailty among their parents or in-laws.”

And that’s just on the personal front. The JPMorgan report explains that changes in politics can mean a change in policies regarding Social Security, 401ks and Medicare; macroeconomic events can impact market returns and real estate values. Add some (or all) of these events atop a savings shortfall, and the result can be nothing short of catastrophic.

“The consequences of not saving enough are pretty dramatic,” Cembalest said. “I think that’s why there are two charts that are central to this paper: the first is the one with the bars with how much you need to save on a precautionary basis to guard against certain events.” That chart is this:

“The second one is just as important and it shows: if you don’t save enough, what happens when you retire,” Cembalest explained. “You can see really dramatic declines in that income replacement ratio, which is fancy retirement lingo for how much money you get to spend in retirement.” And indeed, as the gap between the grey line (your income replacement goal) and the blue bars (your income after adverse events) illustrates, the shortfall is not insignificant:

But for those who are not persuaded by graphs and stats, the JPMorgan report tells a series of stories, too. (The report is actually structured as a treatment for a television show, so every "episode" brings forth one of these stories.) Each story takes a look at an individual or couple and outlines their financial future in a variety of scenarios. In one scenario, everything goes according to plan. In others, the market tanks, a job layoff occurs, or a parent’s health declines. In the final scenario, everything goes wrong at once.

This is the story of Ima Narcissus (yes, the pun is intended). Ima is an affluent individual – i.e, among the 5th percentile of earners – and at the start of her adult life, plans to make a 7.5% pre-tax contribution to her savings every single year; she also benefits from a 3% employer match and saves 2% from after-tax income. Including the benefit of portfolio returns, her lifetime savings rate is a little over 20%. But as Cembalest and co-authors Katherine Roy and Anthony Woods outline in the report, there are at least six major things that can scuttle Ima’s well-laid plans. They are:

Lower financial returns: “A combination of factors leads to modestly lower financial market returns. The primary culprits: worsening demographics in the OECD which result in lower trend growth, and U.S. productivity which remains well below prior peaks last seen in the 1960s and 1990s,” the report says. “Over Ima's lifetime, equity and fixed income returns are 0.75% lower on an annual basis compared with [her ideal scenario]. She will have to make higher savings contributions from pre-tax income -- 9.7% rather than 7.5% -- in order to offset the impact.”

Policy changes on 401ks, social security, etc: “A range of policy changes are enacted to bring entitlements under control,” the report posits. “The impact on Ima: a 1.4% increase, bringing her annual required pre-tax savings contribution to 8.9%.” (JPMorgan figured this out by reasoning that some policy changes already under discussion target those earning more than $250,000; this is roughly Ima’s income level.)

Working until age 65 becomes untenable or undesirable: If Ima were to retire just three years early, "the loss of three years of savings and portfolio income, combined with accelerated withdrawals from after-tax and pre-tax savings, results in a gradual death spiral of Ima's financial assets by her late 70s,” the report explains. Ima’s options are therefore: bump her savings rate from 7.5% to 12% in anticipation of the earlier retirement; cut retirement spending to 45% of pre-retirement spending levels; sell her home at age 79 and live off the proceeds.

The need to pay for elder care: In the fourth scenario, Ima’s parents get sick and need to move to an assisted living. But in order to pay for a facility that meets her standards, Ima must contribute the equivalent of $40,000 (in 2015 dollars). “That amount is in excess of what Ima can fund by cutting annual spending alone, requiring her to take a break from savings contributions for a while,” the report says. “Instead of saving 7.5% per year in pre-tax plans, Ima would have needed to save 9.5% in order to be able to contribute to her parents' assisted living costs while still maintaining her long-term retirement spending goals.”

Home prices plummet: JPMorgan notes that a one-standard-deviation reduction in home price appreciation happens quite frequently; if this were to happen to Ima, her home would appreciate at a rate that is 1.25% below the national average. This means that that if she were to count on living off the proceeds of her home starting at age 79, they would only last until she turned 84 – versus age 88 if the market hadn’t taken a turn.

Everything hits at once: In the final scenario, JPMorgan puts our heroine Ima through the wringer. Not only is she forced to retire early, but market returns take a dive and policy changes impact both her 401k contributions and her effective tax rate. “Ima would have needed to set aside 14% of her pre-tax income in tax-deferred vehicles, in addition to saving 2% out of after-tax income and benefiting from an employer match, in order to prepare for this kind of perfect storm,” Cembalest writes, noting that this perfect storm is severe enough to deplete Ima’s financial assets by the age of 78. “In other words, her annual contributions to savings from pre-tax income would almost have to double.”

Something that could have helped Ima through all of this, Cembalest noted, is an employer match on her 401k that went above the 3% mark.

“This [report] is also a gentle nudge to the defined contribution system that maybe the 3% auto-enrollment rate [for workplace 401ks] is too low,” he said of the report. “I think a company shouldn’t necessarily sit back and rest on its laurels saying, ‘hey we’ve done a great job setting up a 3% auto-enrollment!’ That number works, but when you start throwing snowballs at it, it doesn’t hold up.”

But ultimately, Cembalest said, he hopes the report resonates with the 18-to-34-year-old set and helps them to see that the big things are, really, all the little things -- and the way to prevent the little things from snowballing into something that can upend your golden years is to harken back to a lesson you learned in your earliest years.

"You want the flexibility to help a sibling, or a child or a parent. You want the flexibility to be able to enjoy your retirement, you want the flexibility to be able to see parts of the world you never saw," he said. "Deferred gratification is a concept that goes all the way back to Aesop's Fables and Hansel and Gretel. Every generation in their 20's, there are epiphanies to be had about delayed gratifications. I think it’s important for people keep that in mind."