Will Your Retirement Nest Egg Be “Puny”?
Financial Planners are Not Happy with Retirement Planning by U.S. Workers
I don’t really enjoy starting the weekend with bad news but it seems that financial planning professionals are now openly complaining about their clients. They are complaining about working adults of all ages. They seem to be particularly upset with baby boomers, the bulk of whom are scheduled to start retiring in 2011. Why? Because we are all grossly unprepared for what is to come, as in too much life span left at the end of the retirement nest egg. Mr. ToughMoneyLove wants to explore this a little further.
1. The typical rate of employee contributions to their 401(k) plan is only 3% of salary.
2. The average U.S. worker age 62-65 who is the head of household has a retirement nest egg of only $110,000. This is only twice their median salary of $61,000. By comparison, pension actuaries who design and work with defined benefit pensions recommend a retirement nest egg equal to at least ten times the retiree’s pre-retirement salary. Oh-Oh. $110,000 instead of $616,000? Not good.
What really gets financial planners mad is that there is this enormous pool of baby boomer clients out there who need professional retirement and financial planning help and are willing to pay for it. But with these “puny” nest eggs, these future retirees don’t give the planners much to work with. It is very hard for a competent and ethical financial planner to recommend that a baby boomer move their retirement funds into high risk investments in a desperate attempt to play nest egg catch-up. In fact, there is not much they can say to these clients except to plan on working well beyond their planned retirement age.
Young and Old, We all may be in Nest Egg Trouble
If you are not a baby boomer, you may be thinking “this has nothing to do with me – I have plenty of time to prepare.” Mr. ToughMoneyLove begs to differ. This bad news has a lot to do with you, for two reasons.
First, if millions of baby boomers become destitute in retirement, they will first become unhappy and then angry. Destitute, angry baby boomers will vote in very large numbers. They will vote for politicians who increase the government entitlement programs, such as Social Security and Medicare. Who do you think will be taxed to oblivion to pay for these? That’s right – you young folks who are still working. Sorry about that.
Second, as young as you may be, your savings rate may already be on track to produce a “puny” retirement nest egg. Ms. White, in consultation with a pension actuary, calculated the minimum 401(k) contribution rates for different age groups that would be necessary to create an adequate retirement nest egg.
If you start contributing at age 25: You must contribute 10% of salary
If you start contributing at age 40: You must contribute 23% of salary
And, if you don’t start contributing until age 50: You must contribute 48% of salary!
If You Start Too Late, You may Never Catch Up in a 401(k) Plan
Now you may have observed from the data above that 401(k) contributions corresponding to 23% to 48% of salary are likely to exceed the current 401(k) contribution limit of $15,500. Even if you are a late starter over 50 and can contribute an extra $5000, that is unlikely to get you to the needed 48% of salary. In other words, based on these calculations, it is too late to “catch up” for many inside a 401(k) plan. If you are in that predicament, you need to build a secondary retirement nest egg outside your 401(k) plan.
As a cure for the failures of American workers to plan for themselves, Ms. White proposes that U.S. employers be required to contribute to their employees’ retirement accounts at a 9% rate. (Apparently, this is what is done in Australia.) I am opposed to this. Employers are already contributing over 7% for Social Security and Medicare. Look what is happening with those programs. Ms. White’s attitude just feeds the mentality that U.S. adults are not capable of taking care of themselves and that the blame for poor planning must be shifted to others.
I would be in favor of mandating that all employers offer either a defined benefit plan or a 401(k) plan to their employees. Right now, that is not the case. I would also be in favor of requiring all employees to contribute to their 401(k) plan at a 9% rate, starting with their very first job and continuing until retirement. And NO 401(k) LOANS OR EARLY WITHDRAWALS ALLOWED! Now, too many employees are borrowing or cashing out their futures in a futile struggle to maintain an inflated standard of living.
There Are Better Alternatives to the Ten Times Salary Guideline
Finally, I submit that the calculations made by Ms. White and others in the conventional world of retirement planning are overly simplified and may result in undersaving and sometimes oversaving. Instead, there should be increased emphasis on consumption smoothing. I will be talking a lot more about this concept in future posts.
I am also going to be critiqueing the income replacement percentages (80% or more) that are so often recommended by brokerages, mutual fund companies, and even financial planners. It seems that too many players in the financial services industry are focusing on retirees’ working income instead of what their actual expenses in retirement will be. Why? They want panicked boomers to invest more because that makes them money. Anyway, more on this later.
Meanwhile, if the data reported above puts your nest egg in the “puny” category, please consider doing something about it, starting now.