10/06/03 - The Retirement Time Bomb
By: Richard Feldman, CFP, AIF, MBA
Planning for retirement has become more crucial today than ever as baby boomers move towards retirement with decreased Social Security benefits and deteriorated retirement plans. In light of the well known retirement problems, you would expect to see the savings rate in America increase over the last few years to make up for the deficiencies in the system, but the exact opposite has occurred. The personal savings rate in America has continued to fall below 4%, which is a considerably less than historical savings rate. The financial press has praised the fact that the American consumer continues to spend a large percentage of their disposable income and has referenced this fact as a key component in helping our economy avoid a recession but I have to wonder at what cost? The national savings rate averaged 1.1% of Americans' aftertax income in June 2001 (according to the Commerce Department's Bureau of Economic Analysis). Americans are jeopardizing their well being in their later years through inadequate retirement preparation and savings.
The following chart shows the personal savings rate in America:
Source: U.S. Department of Commerce: Bureau of Economic Analysis
The Three-Legged Stool
Retirement income has often been provided by the "three legged stool" concept that identifies three major sources of retirement income:
- Social Security Benefits
- Employer-Sponsored Retirement Plans
- Personal Savings
The three-legged stool concept holds that 15%-25% of retirement income should come from Social Security, 0%-60% from an employer-sponsored retirement plan or pension plan and any gap between the two should be filled by private savings.
The Problem With Each Leg
Corporate Pension Plans - The trend in company retirement plans is also placing more responsibility on the individual. In recent years, companies have increasingly shifted from defined benefit pension plans, which guarantee workers a predetermined retirement income, to defined contribution retirement plans, where the employer may match the employee's contributions to a tax-sheltered retirement plan. The plan's benefits will depend on how successfully he or she invests the money in the plan.
Recent research has suggested that the average worker is having much less success investing their retirement plan assets in comparison to the old defined benefit structure where the employer solely funded and managed the investments on behalf of the worker. Employees are often confused and intimidated by the myriad of investments choices offered through their retirement plans. This often leads to disillusionment with the plan and a lack of participation by American workers.
Social Security - Starting in the year 2000, the age at which full Social Security retirement benefits are payable was raised for anyone born after 1937. For those born in 1960 or later the normal retirement age rose from 65 to 67. Benefits are still available at age 62, but they are permanently reduced by 30%, compared with a 20% cut for previous early retirees.
Social security will contribute proportionately less to retirement income and the trends in company retirement plans are placing more of the responsibility on the individual.
Personal Savings: Personal savings should be a key component of every retirement plan but will be even more important for future generations and we are not saving enough. In any event the bottom line is that you can't afford to rely on the government and your employer to finance your retirement program. A significant portion of your retirement income will need to come from a regimented personal savings program. But there is little evidence that a majority of Americans have come to this realization or have begun a program to add the third leg of the puzzle - personal savings.
Do People Think That They Are Saving Enough
Retirement confidence and planning are closely linked with doing a retirement needs calculation. The Retirement Confidence Survey (RCS) gauges the views and attitudes of workers regarding their preparations for retirement. In 2001, 46% of workers reported that they have at least tried, although not necessarily successfully, to determine how much money they will need to save for retirement. The survey also revealed that 60% of workers feel that they are behind schedule for planning and saving for retirement. Only 5% feel that they are ahead of schedule.
Analyzing Retirement Needs
Generally, your retirement needs analysis will reveal a retirement income gap. The gap is the difference between the income you expect to receive from Social Security, a company sponsored pension, and personal savings compared to the amount of income you think you will need during retirement to maintain your current lifestyle. The easiest way to alleviate that gap is to begin a regimented savings program now. Put time on your side. The earlier you begin saving for retirement, the less burdensome the task, because your money will have longer to work for you. The miracle of compound interest will be on your side.
The Retirement Confidence Survey (RCS) found that workers and retirees spent more time in the last year planning for holidays and social events than planning for retirement. If we want to enjoy our golden years, we should probably spend less time on how we are going to spend our money on social events and more time on developing a sound retirement plan.
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