Friday, August 23, 2013

You Are on Your Own: Retirement Saving

You Are on Your Own: Retirement Savings

Charles Schwab released survey results earlier this week that caught my attention.  Among more than 1,000 random participants (not necessarily Schwab clients), 89% are counting on themselves to fund retirement, and 61% are relying exclusively on their 401K balances.[1]

Employment Contract (1997)

According to a Fidelity Investments survey, the average 401(K) account balance was $77,300 at the end of 2012.[2]  As you’d expect, those 55 and older had larger balances -- $143,300, while young workers, those born between 1979 and 1991, had an average balance of only $15,400.

Now take a look at the table below from a 2012 survey conducted by the Employee Benefits Research Institute of 401(K) balances by age and tenure to get a better picture of where the account balances are relatively strong and where they are relatively anemic.  I know the data is a bit old, but even if you bump up the balances by 15% or 20%, most employees over age 60 (bottom of the table) are going to outlive their assets even if they work well into their 70s.   Those in the younger cohorts aren’t saving enough.

Despite the myriad of media headlines warning of the looming retirement crisis, a lot of people really don’t know how much it will cost to retire.  According to a 2013 EBRI report, 51% of all workers think they’ll be able to retire on less than $500,000 in savings.   This kind of balance won’t come close to doing the job unless they die four or five years after they stop working.  As you read across the table from left to right, you’ll see that folks don’t become smarter about this state of affairs as they age.

What’s the answer to this investment conundrum?  I know it’s not popular and it’s not the trend, but we need to return to the true purpose of 401(K) plans (see, “Unintended Consequence [September 24, 2012]” for a brief history) as supplemental retirement plans.  Not only are employees grossly underestimating how much it will take to retire, those who sit down to draw up an estimate will find that it is a complicated exercise.

Yesterday I wrote about North Carolina Supplemental Retirement Plans.  The average account balances by age cohort are set out below.  At first glance, the balances look lackluster and pale in comparison to the results disclosed by Fidelity.

How is a 70 year-old going to retire on only $49,000 plus Social Security?  The reason those balances are perfectly acceptable is because NC is using the 401(K) for its intended purpose as a supplemental retirement plan.    The State’s pension plans are the main form of retirement savings.  Aren’t NC’s public employees getting a free ride via the defined benefit plan?  Hardly.  North Carolina’s employees contribute 6% of their salaries to fund the DB program, so those participating in the 401(K) program have some of the highest savings rates in the country.  As I pointed out in “Confronting Our Pension Challenge in North Carolina [May 7, 2013]” NC’s state employees have contributed much more to the defined benefit plan than the taxpayers over the last decade.

The defined benefit plan, for all its imperfections, at least contains a mechanism for calculating what it will take for the average employee to have a decent amount of retirement savings by tying the benefit to a fraction of the employee’s salary.  Rather than killing DB Plans, we should be expanding them.

The publicly employed North Carolinians who have managed to contribute to the State 401(K) should receive an award.  Despite paltry pay increases over the past decade and severely diminished benefits, they are managing to save for their retirement.  If our legislature has its way, they will eventually join the vast majority of respondents to the Schwab survey who report that they are on their own.


1 comment:

  1. This article has clearly described about the retirement plan. It acts as a part of back up plan if any unexpected occurred.