The Employee Benefit Research Institute (EBRI) does an annual study called the Retirement Confidence Survey (RCS). The RCS typically shows that Americans are not saving enough for retirement and that many people simply have no idea how much they need to save. The 2011 study is no exception. Among other things, the RCS asks participants how they are estimating how much they need to save and where their current estimates fall.
The 2011 survey finds:
- Only 42% of workers have even tried to calculate how much they need to accumulate in order to retire
- 31% of workers think that they can retire with total savings of $250,000 or less
- 19% of workers think that they can retire with total savings of $250,000 to $500,000
These numbers are pretty close to the RCS findings in the past, and the longer these numbers hold, the more it is clear that the self-directed retirement planning process is not succeeding.
Why Don’t We Focus on Our Retirement Needs?
What does it mean that less than half of Americans surveyed have not even tried to estimate how much they need to save for retirement? There are four possible explanations:
- The first explanation is that people simply don’t know where to look for good estimates for how much they need to accumulate.
- The second explanation is that people don’t really want to think about how much they should be saving.
- The third explanation is that the respondents are too busy managing their day-to-day lives and paying today’s bills to spend time planning for their futures.
- The fourth explanation is that they simply plan to work until they can retire–perhaps for the rest of their lives.
Regardless of the reasons, not having a reasonable basis for how much is needed for funding retirement makes it far more likely that people will not save enough. Indeed, the RCS shows that people who have tried to estimate their future financial needs do save more.
Changing Expectations About Retirement
The 2011 study shows that expectations about retirement are also changing. There is a growing general trend towards an expectation of retiring at a later age. In 1991, only 9% of respondents planned to retire at age 70 or later. In the 2011 survey, 25% of workers plan to retire at age 70 or later. More people plan to work part time in retirement, too. These trends will certainly help people who have not saved enough, but are they enough?
A general rule of thumb is that you can plan to draw 4% of a portfolio’s value each year as income (adjusted each year to keep up with inflation) and expect to be able to safely sustain that income for as long as 30 years. This guideline is called the 4% rule. This is a surprisingly good place to start for planning. On the basis of this rule, you could expect to draw $10,000 per year, adjusted for inflation, if you retire today with $250,000 in savings.
We can compare this estimate to Vanguard’s online planning tool. Vanguard’s tool allows you to vary the amount in stocks vs. bonds and see how likely a plan is to work. If you go much above a 4% draw rate, you will see that the probability of funding a long-term retirement income (20+ years) drops dramatically, regardless of the asset allocation. In my opinion, the Vanguard tool has a built-in feature that makes its estimates too optimistic. The tool also doesn’t address accumulated fees or expenses associated with investing (mutual fund fees, brokerage, etc.)
Saving Too Little
So let’s assume that the 32% of workers who believe that they can retire on $250,000 do in fact save this amount. We then can estimate that they will be able to draw only about $10,000 per year from $250,000 (we can raise this amount somewhat if we assume that our hypothetical retiree buys an annuity).
Needless to say, this income level is not likely to be what people expect.
After all, by this formula, someone who retires with $1 million can only expect $40,000 per year in income. Of course, since many people are not going through any type of calculation process, it is a safe assumption that these people have no concrete basis for figuring how much they are going to be able to live on at all.
The evolution towards self-directed retirement plans has resulted in a world in which more than 40% of people report that they are really just guessing how much they need to save for retirement. Inevitably, without a concrete goal, people end up saving too little. It is encouraging that fund firms and others are providing tools to help in the planning process. The results from the RCS suggest, however, that many people are either unaware of these tools, or do not understand how to go about coming up with realistic estimates of how much they need to save.