One of the things many people hope for today is that when they stop working, their retirement will be a comfortable one at least in terms of paying everyday bills. The foreign travel or golfing everyday will be the icing on the cake so to speak. Many people of my parent's generation had the benefit of working with established companies for most of their lives and may have been fortunate to receive a small company pension. With government pensions along with whatever savings they have, they will be comfortable for most their retirement barring any major health problems that prove to be chronic.
Generation X: spenders not savers
For my generation it is a different story. Most of us do not work at companies very long now nor do these companies offer a pension plan to new employees. In fact, major companies are seeking to reduce their pension obligation for current and future retirees. The days of the defined benefit pension are numbered. In its place, if a company ever bothers to set one up is the defined contribution pension of which the best known is the 401k plan. A company may provide matching a small percentage of the employee's contribution but it is typically less than what the company would have contributed under a traditional pension plan. The onus is now on the employee to handle his own retirement needs. Yet most people find it hard to do so. Yet the myth that contributing to a 401k plan will take care of all of your needs threatens many when they reached retirement of going into penury.
The bottom line is that most people do not have the ability to contribute significant amounts of their income to a 401k plan. The IRS allows people to contribute about $15,500 year maximum tax-free into a 401k plan but only a small number of workers, professionals generally making over $200,000year, can do so. Most everyone else who is part of a 401k plan contributes far less than the maximum amount. A telling statistic is that the average 401k plan at Fidelity investments, one of the largest 401k managers, has about $71,500 in it. If you retire at 65 and have a life expectancy of 20 more years, $67,000 will not take you very far. But the problem with this statistic is that it is an average; the more revealing statistic is that the median amount (i.e. the middle point) of 401k plan balances is $35,000. When you have this large discrepancy between the average and the median, you do not get a nice bell-shaped statistical graph but something more like an inverted bell-shape as the values skewed higher at the extremities of the values. In plain language, there are many people with high balances in their 401k plan and many others with very low balances and not too many in between.
The fact that 50% of all 401k plans have a balance of $35,000 or less is a cause for worry but not unsurprising. Many people in the prime of their working lives do not give much thought to retirement. Many are juggling household budgets, paying off a house mortgage and handling education expenses for their college bound children. At the end of the day, there is usually not enough left over to put aside for the future. But it is not the future that concerns most families. It is the present and in this consumer driven age, people are more inclined to spend on items they want today and worry about tomorrow for later. This is a generation that is not much into self-denial. Then again others are just trying to survive from day to day. This is especially true for lower income workers: to ask them to put $4000-5000 /year aside out of $18 -24,000 income into a private retirement plan is just not doable no matter how tax breaks they can get. It is only through their mandatory Social Security income deduction that they have a chance to put something aside for retirement. But of course, their Social Security contribution does not really go into a special account for them but rather pays for the current pensioners in the system.
This is not to say people are unconcerned about retirement. When President Bush launched his Social Security reform debacle, it was generally told that the highest resistance came from current retirees. While this is true, a majority of people in my generation also were against it because we realise that when left to our own devices, we will never put enough aside to take care of our own retirement. Social Security will be the main source of income for most of our retirement supplemented by Medicare for health expenses. Social Security began as a promise that the country's elderly will not have to face poverty when they are unable to work anymore. Through various factors (demographic changes, increased lifespan, richer level of benefits) Social Security will become one of the most expensive parts of the country's fiscal budget in the not too distant future but there is no other alternative for most people when they retire.
Doing the minimal with a plan
When people set up a 401k plan, it is thought that they will be diligent stewards of their plan, seeking to maximise their return. In reality, most 401k contributors fail to even check their quarterly balances. Part of the problem is that they remain uneducated about their plans and making choices depending on what life stage they are at. Most opt for the most conservative plans at the beginning of their careers when a more aggressive stance should be taken. Some take their employer's stock as their only investment which can be a costly choice in the long run. The example of Enron is a cautionary guide on how their employees' retirement accounts, nearly all vested in Enron stock, were wiped out when Enron went bankrupt.
Sometimes there is too much choice to select from and people try to diversify too much or too little because it takes time and effort to figure out what are the better choices. Some employers have as few as three or as many as twenty different mutual funds that be selected as the basis for a 401k plan. Relying on the investment guides for each mutual fund can be a problem as all of the figures are based on past performance and you need to be educated through research to determine what will be the better performing funds for the future. For many, this is too much work so it is simpler to just pick a fund and stick with it without any regard for the consequences.
Finally, there is the question of fees. The stock market environment of the past few years has generally classified as having a sideways performance, not a bull market but not a bear market either with some sectors doing better than others. Consequently the large percentage gains common in the late 90's, the annual 15-20% returns are not be found. To receive a return of 6-8% annually may be more realistic these days. The problem is that the fees that the fund managers can charge to manage a fund may be anywhere from 0.5-2.2% of a fund and that will reduce the return from the investment. Then inflation has to be considered as well in the real rate of return and we are living in a time where inflation is trending upward. Put it altogether, a high fee mutual fund in a time of moderately high inflation may actually give you a real return on an annual basis next to nil for the fund.
There is one good boost to someone's 401k plan that many do not take full advantage of and that is the matching contribution by employers. To get the full benefit of it, you may have to stay with a company for a while during the vesting period, typically 5 years. The amounts may never be great: 50-100% of a percentage of your contribution to a certain maximum but it may be the only real gain you can make in a market with low growth. But again, to get the full benefit of it, you have to contribute at least to the max contribution made by the employer.
A low-growth strategy
The final myth of a 401k retirement is that many people keep quoting yearly growth rates as the stock market is enjoying the double digital increases it had in the late nineties. Those times in retrospect appear to be an anomaly. Single digit growth may be more realistic. So to have a bigger fund to live off when you retire, you will have to contribute more but people are still being marketed to with information that they can retire on limited contributions because the stock market will magically double your money in five years. Just wish it was that easy.
For young contributors, it is preached to invest in more aggressive funds as losses in one year can be made up in following years. But what about low growth years? It may sound contrarian but I invest 25% of my 401k into funds that provide income through interest or dividends. It may sound conservative and more appropriate as you approach your retirement years but I found that in the past two years, this income has done much better for growth in my funds than the various equity funds.
What are we to do?
Unless you are able to comfortably contribute the maximum amount into your 401k plan every year and have done so for 25-35 years, it is difficult to foresee how you can live off what people typically contribute into a 401k plan. Many people have written or spoke on the need to contribute much more than they do into a plan. Too many assume that the 1-3% of their gross income is enough to build on but it is not. Even if you contribute close to the maximum, too many assumptions have been made on the return the stock market can provide in growing the funds.
In the end, those 20-30 years of retirement income will have to come from a variety of sources: company pensions (if they still exist), 401k or similar plans like IRAs, social security, reverse mortgage equity loans on homes, and maybe part time work.
Shaken
Of course, as we have seen in the past month, all of the good intentions to diligently save a significant part of your retirement can go to pot with a massive downturn in the market. It may be paper losses as the number of units did not reduce, just their price.
More than anything else, though, such financial events shake people's confidence in the system. Our whole economy is based on trust. Trust in the value of the currency, trust in the banks to keep our money secure, trust that we have a retirement fund to rely upon. What this current crisis has done is undermine the faith to some degree for now that 401k plans can be relied to take care of our needs. What may happen now is that people may pull back their contributions to their plans in favour of a simple savings account. At least the value of that will be guaranteed for the most part unlike the current volatile stock market.
Always think long term is the mantra especially when considering retirement funds. Heard that from my company's financial adviser this morning as she gave us a pep talk on keep doing the right thing and still maintain our contributions to our plans. Long term makes me thing of another saying, by John Keynes that in the long run, we are all dead.
The golden years may not be so golden.
Update with statistics
Some people are interested in more specific data. Some of the figures quoted above are for all accounts but if you are interested in figures for something closer to retirement age, here are some 2007 figures.
Salary Range | 50s Median Account Balance | 60s Median Account Balance |
$20,000 - $40,000 | $76,788 | $64,147 |
$40,000 - $60,000 | $99,932 | $97,588 |
$60,000- $80,000 | $163,935 | $160,051 |
$80,000 - $100,000 | $243,382 | $237,303 |
More than $100,000 | $367,413 | $350,576 |