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• How much are Americans saving, and how much do they need to be saving?
• Why retirement is so expensive
• Common 401(k) mistakes
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• Why Does Retirement Cost So Much?
  One expert advises saving 15 times your salary for the golden years.

HOW MUCH ARE AMERICANS SAVING, AND HOW MUCH DO THEY NEED TO BE SAVING?

Jack VanDerhei
Senior Research Fellow, Employee Benefit Research Institute (EBRI)

At the Employee Benefit Research Institute, you follow retirement. When you look at the record, particularly with these 401(k) plans, how well are people doing in terms of saving? What do you see in people's balances in their 401(k) plans, particularly in that group right on the verge of retirement?

... We have a database that actually goes back 10 years now. The most recent year-end 2004 numbers that we have analyzed were [for] 16.5 million individuals. ...

The ones today that are approaching retirement age typically have on average around three times [their] salary. If their final salary is, let's say, $50,000, on average they'll be [at] about a $150,000 account balance. But the thing that you have to keep in mind is that the 401(k) system literally has only been in place about 20 years, so these individuals only had an opportunity to spend about half of their career in these plans. So by and large, it's probably not going to be enough, when combined with Social Security, to help the people right on the verge of retirement have adequate retirement income.

Now, if you turn the question around and say, "What do I need in my retirement account so that, along with Social Security, I can make it?"

That's a very good question. If you have nothing but Social Security and your 401(k) accounts, if you want to retire at 65 [with 80 percent of your pre-retirement income] and you're male, [you have to have] about 6.3 [times your pre-retirement annual income]; if you're a female, about 6.7. The reason, of course, is you have a longer life expectancy if you're female than male. If you want to retire early -- say, at age 60 -- those numbers are going to increase up to about 6.9 [times pay] if you're male, and about 7.2 [times pay] if you're female.

So let's translate this into dollars and cents. You've got Social Security. You're looking to maintain your living standard. If you want to retire at 65, and you're making $50,000 a year, you have to be in the neighborhood of 300,000, 325,000 bucks in your 401(k) plan.

That's correct.

And if you want to retire at 60, you're looking at $350,000, $360,000, $370,000.

Right.

And most of the people we're looking at are half that or a little bit below.

On average, yes.

What does it take, if you're working for 30 years and you're in a 401(k) plan -- that's all you've got: 401(k), Social Security -- how much do you have to put aside every year? What percentage of your salary?

... If you're a male and you want to get out at age 65 -- you're going to work those 30 years you mentioned -- about 13.3 percent total. That's the employer and the employee together -- 13.3 percent of compensation each and every year.

Wow.

If you're talking about a female getting out at 65, it goes up to 14.1 percent -- again, because of the longer life expectancy.

What if you want to retire at 60?

... For the male, it goes from 13.3 to 14.5 percent a year. For the female, it goes from 14.1 up to 15.3 percent a year.

So whatever you're doing, you're saying 14 or 15 percent a year is what you're going to need to be putting in 30 years in a row.

Combined employer-employee, that's correct.

An awful lot of employer-employee plans are not -- the employee puts in, max, 6 percent, employer matches 3 percent, [so] 9 percent total. We're falling far short.

For those individuals who are putting in only enough to get the maximum out matched by the employer, I agree entirely with that.

Brooks Hamilton
Benefits Consultant, Brooks Hamilton & Partners

The boomers will be the first, I think, to really be bitten. ... The executive vice president of a major mutual fund family has told me that the average boomer makes $50,000 a year, and the average boomer has $100,000 [in their 401(k)], so the average boomer has two times pay. ... You can only stretch the dollar so far. If they retire on two years' pay, the boomer making $50,000 a year that retires with $100,000, that $100,000 would probably let him have about $700 or $800 a month for life, instead of retiring on two-thirds pay, which is ... $3,000 a month. ...

Probably forgetting Social Security, ... the average worker probably needs 10 times pay.

Plus Social Security. ... So if you're making $50,000 a year, you should have --

Five hundred thousand dollars set aside. ... To me, it's a hurdles race, and there are three hurdles to get over. First hurdle: You must join the plan. Second hurdle: You must make material contributions -- and I'm talking 10, 12 percent by the employee. You must tithe to yourself, and you've got to start in your 20s. This is serious stuff. And the third hurdle: You've got to make market returns. You don't have to beat the market; that's a fool's game. You have to be the market. ...

You, as an employee, need to be putting aside 10 or 12 percent a year. Is that right?

Yes, that's what I said.

Plus the employer match.

That's right.

So what are you saying has got to be the savings rate of the employee and the employer combined, say, over 30 years, to have a decent retirement?

Fifteen to 18 percent of pay.

... And most plans think they are doing a great job if, combined, the employee and the employer are putting away 9, 10 percent.

They are half what they need to be. ...

David Wray
President, Profit Sharing/401k Council of America

To be really safe, we recommend that you shoot to have in all your assets -- this isn't just investable assets, but all your assets -- you need to probably have 10 times your final pay, and that will pretty much carry you through. So if you're making $40,000 when you retire, you probably want to have $400,000 in assets. ...

So if you take a worker who's worked 20 years, what do the worker and the employer together have to put together every year?

If it's only a 20-year period, you're looking at a substantial contribution rate; you're probably looking at 15 percent [of pay]. Remember, this is conditioned on returns. We use 8 percent [return] as our calculator in that regard. ...

Let's take it [to] 25 years [of saving]. What have you got to do then? How much do you have to put in?

You're moving the number down because [of] compounding. You're down to 12 [percent of pay].

What percentage of the workers in America in the private sector today are putting away 12 percent?

... I would estimate that maybe 20 to 25 percent of workers are putting 12 percent away. ...

John C. Bogle
Founder, Vanguard mutual fund firm

What do people need to put aside to have a decent retirement that will enable them to live at roughly the same standard of living that they were living at when they were working?

To begin with, it's age-intensive. If you start early, it can be a much smaller portion. If you get to age 40 and haven't started, you probably have to put away 25 percent of your income.

So what do you say to the great mass of people who feel terrific about putting away 6 percent a year, with a 3 percent employer match -- that is, 9 percent a year combined starting at around age 35? What do you say to them?

You'd better step it up if you're putting 9 percent in at age 35, and you'd better also do some other very significant things. One, you'd better keep [the investment] costs down so you aren't overwhelmed by the tyranny of compounding costs, whatever market return you might get. ...

 

WHY RETIREMENT IS SO EXPENSIVE

Jack VanDerhei
Senior Research Fellow, Employee Benefit Research Institute (EBRI)

Do Americans get this tough picture? I don't have a sense that people are aware of this.

... I don't think the vast majority of individuals have any idea what's coming down the road as far as some type of social outcome. ... People tend to minimize what they think their life expectancy will be. They tend to assume that they're going to continue in relatively good health if they currently have disastrous medical history. ... Things like long-term care insurance are not actively purchased. Annuitization is not something that's done very frequently. ... Because of retiree health insurance being shifted to the employees, ... [they] are basically one misstep away ... from financial ruin. ... They don't factor in the fact that a year or two in a nursing home could totally disrupt their entire financial plans. ...

Brooks Hamilton
Benefits Consultant, Brooks Hamilton & Partners

The problem that they're going to have, that few people talk about, is ... inflation. ... It's a new problem for us today because of the explosion in life expectancy. So if a guy retires at 65 and lives until he's 90, that 40 percent, 45 percent [of their pre-retirement income] is going to be cut in half, and maybe cut in half again, by inflation. ... It's going to melt away. ...

... So ... we've got a really different kind of retirement financial problem than we thought. We've got long life, we've got huge health bills, and we've got long-term inflation. ... What is it we don't get when we look at our retirement, and why is it such a shock to people when they discover how much they need?

It's human nature to think your problem will be somewhat like your father's, your grandfather's, ... and it wasn't a big deal for them. Looking in the rearview mirror ... is very misleading, because it's not where we're going. It's not what's coming. The fact is the average person is going to retire and maybe live 15 or 20 years, and the risk of post-retirement inflation is huge. It's a problem our father or our grandfather were not concerned about, and so it's a problem we're not concerned about. It's a problem that we must become concerned about, or we're going to run out of money before we run out of living. That's the real risk I see in the industry. ...

David Wray
President, Profit Sharing/401k Council of America

American workers enter the workforce totally financially unprepared. They don't understand compound interest. They don't understand saving. ... It takes a number of years, even in an employer plan where the employer is diligently educating people, for them to understand and appreciate that they have to save money and put money aside for retirement. We are talking about maybe a generation or two of education from all of our institutions. The employers certainly are part of that program, but we need the schools to change and teach people. We need the government, policy leaders, to use the bully pulpit and tell people about this. This is a different kind of world than the one that young people's grandparents grew up in, and they are not prepared right now to do that. ...

 

COMMON 401(k) MISTAKES

Jack VanDerhei
Senior Research Fellow, Employee Benefit Research Institute (EBRI)

Number one is the low participation rates among young and low-income workers; [second], contribution rates which are necessarily only going to get the maximum amount matched by the employer and no more; thirdly, the way you invest.

There's two problems with investments. You've got a whole group of people, even young employees, who are so risk-averse that they don't invest anything in equities. Now, it's one thing if you're 64 and a year away from retirement, thinking, well, I don't want to face a down market, and pulling out. But if you're talking about people in their 20s and 30s who don't have anything in equities, you're simply not going to have a large enough rate of return to get investment income to supplement your contributions to give you the kind of standard of living you're going to need in retirement. That's one problem.

The other problem is diversification. We still have more than 10 percent of employees ... that have 80 percent or more of their entire account balance invested in company stock.

What's wrong with that?

... The problem is you not only have your entire job future invested in that company, but now you have your entire retirement security also. It's much easier to diversify at least portions of that risk by getting in a broadly diversified equity index fund.

So you've got too much at risk in one place, ... too many eggs in one basket. ... Participation, contribution, investment -- OK. What's number four? What's the next big problem?

Among the young and those with small account balances, which is not necessarily ... constrained to only the young, there is an extraordinarily high probability that when you leave one job for another, that instead of rolling over those monies to an IRA or to a new employer or keeping it with the old employer, you'll actually take the monies out. ... Once that money is out, it's probably never going to go back into your overall retirement accumulation.

How big is this problem of leakage, of people cashing out their 401(k) plan when they move from one job to another?

The problem is actually quite large. If you look at people in their 20s, about 70 percent of the people cash out [their 401(k)s]. If you even go up into the 30s, you're still talking about maybe 55 percent of individuals cashing out their account balances -- monies that were there for retirement being spent on other purposes.

So the whole idea of saving for 40 years goes out the window, and suddenly you're now saving for 20 or 25 years.

Exactly. ...

When people retire and they get their hands on the money, is there a danger that someone will spend the money too fast because they don't have any idea how long they're going to live? How can you track that?

If you take a look at some of the government studies that have been done in the last 10 years that track individuals every two years after they retire, and you compute how much they should be spending each year to be able to maintain [their savings] to at least life expectancy, ... you find a substantial portion of them spending down the monies [more] quickly than they should in that case.

A substantial portion? Ten percent? Fifty percent?

It's certainly around 25 percent to 30 percent under most assumptions we've made. ...

Alicia Munnell
Director, Boston College Center for Retirement Research

Jack Bogle says that the average investor cannot do as well as the market averages, because if you use a mutual fund or some other vehicle like that, they're going to take 2 percent in fees, so what should be an 8 percent gain is a 6 percent gain. It doesn't sound like much, but if you add it up over 20 or 30 years, you're going to wind up seeing a third, 40 percent, even 50 percent of your portfolio gone in these little-looking fees. ...

There are two things. I think that the fact that the individual keeps meddling with his or her account really reduces your returns. And then you're right: The fees are an issue. The fees aren't much of an issue when the stock market's going up 15 percent a year. The fees are a big issue when it's going up at 5 percent a year and you're losing 1 percent on your return year after year after year. A 1 percent fee over a 40-year lifetime reduces your final pile by 20 percent. That's a big chunk. ...

Everything has gone wrong. The individual has to make a choice every step along the way. [The] individual has to decide whether or not to join the plan, how much to contribute, how to allocate those contributions, how to change those allocations over time, decide what to do when they move from one job to another, think what to do about company stock. Then the hardest thing, which we haven't even gotten to, is what are they going to do when they get to retirement and somebody hands them a check? How do you figure out how to use that over your retirement span? ...

David Wray
President, Profit Sharing/401k Council of America

Everybody doesn't have to be good at it, because ... the system is being revamped to change the dynamics. Employers are moving in to manage the money for the employees. You're right: In the late '80s and early '90s the concept was, "You have to manage the money yourself." There was an anticipation that we could teach every American worker to be an investment manager. What we have learned is that's not true.

They're not good at it.

They're not good at it, and they're not going to be good at it, ... certainly not in this generation of workers. ... So what do we have to do? We have to address that. Companies are addressing that. ... The system is going to where employees do nothing, and good things happen. Money is going to be taken from their paycheck and put into these programs, and then it's going to be automatically invested in an appropriate, diversified program on their behalf. They're not going to have to worry about making an allocation decision or rebalancing or other kinds of sophisticated decision making. The system is changing. ...

John C. Bogle
Founder, Vanguard mutual fund firm

I'm a complete believer in capturing the market return through an index fund rather than taking probably about a 5 percent chance over an investment lifetime of beating the market after all those costs. ...

But one of the ideas behind the 401(k) was, "You can do it!" You own it; you run it. And you've got millions of people out there saying, "I can beat the averages." What do you say to that?

I say, don't kid yourself, pal. Look, it's so simple. We're not like the kids out in Lake Wobegon. As investors, we are all average, and as investors, we all share the stock market's return. It's going to turn out to be 8 percent return, we're all going to share 8 percent return, but only before costs are deducted. We all share the market's return less the cost of the financial system. All those management fees and brokerage commissions and sales loads and God knows what else is thrown in there -- the advertising that you see. So if investors would just use index funds, and particularly the cheapest ones, they would, by definition, capture the market return, or almost all of it. ...

Alicia Munnell
Director, Boston College Center for Retirement Research

The question is, why do people end with such small amounts? Why do people make such bad decisions? Let me assure you, it's not [just] them. ... I have made virtually every mistake that I look out there and see other people doing. We live busy, complicated lives. Saving for retirement is a really hard thing to do. You have to look way ahead. You have to put other demands aside. You have to resist temptation when you have the chance to get this nice pile of cash that would really solve all your problems. We're all just pressed, and so we don't make smart retirement decisions. ...