By Robert Powell, MarketWatch, May 25, 2013
Odds are high that you haven’t saved enough money to retire in the manner in which you desire. That’s the bad news. The good news is that you can easily gauge just how close or far away you might be. And the first to thing to check is how much you have set aside for retirement.
The average so-called full-career worker at a large employer needs to have 11 times their pay, after Social Security, set aside at age 65 in their retirement nest egg to expect to have sufficient assets to get through retirement.
Or least so says research conducted by Aon Hewitt, which has been studying whether workers at large firms will have the financial resources to meet their post-retirement needs since 2008. Including Social Security, you will need 15.9 times pay to maintain your standard of living throughout your retirement years.
According to Aon Hewitt’s Real Deal 2012 Retirement Income Adequacy at Large Companies study, workers who have 11 times pay set aside when combined with Social Security will be able to replace in year one of retirement 85% of their pre-retirement income. Read that research. The 85% rule of thumb reflects one’s final salary, adjusted for decreased savings and taxes, increasing medical costs and changing expenditures in general, and inflation.
Of course, there are some adjustments that must be made to this rule of thumb based on your income. (We’ll talk more about that in a second.) But in essence, one quick way to determine if you’re on track to having enough money for retirement is to divide your assets earmarked for retirement by your salary.
So, for instance, if you’ve got $500,000 set aside and your salary is $50,000, you’ll have 10 times your pay to fund your retirement, which, based on Aon Hewitt’s study, is just barely enough money to maintain your standard of living in retirement.
Will you be prepared if you keep doing what you’re doing?
Now truth be told, many workers don’t have enough set aside to maintain their standard of living in retirement. In fact, the Aon Hewitt study projects that the employees who currently contribute to their employers’ savings plans and who retire at age 65 after a full career will, on average, accumulate retirement resources of 8.8 times their pay, which is a shortfall of 2.2 times pay. Workers who don’t have a defined benefit face a shortfall of 3.8 time pay.
Of course, averages can be misleading. So for context, consider this: Some people are on track to retire in comfort and some are off by quite a bit, according to Aon Hewitt’s study.
Almost 30% of employees are now on track to retire comfortably at age 65, while 21% of employees are expected to have a shortfall of more than six times pay at age 65.
For the record, the resources calculated by Aon Hewitt include accumulations of employee savings in their employers’ defined contribution plans (4.1 times pay), accumulations of employers’ additions to defined contribution plans (2.6 times pay), and defined benefit pensions (2.1 times pay).
Workers saving for retirement using a Fidelity 401(k), by the way, now have on average $80,900 in those accounts and workers 55 and older have, on average, $150,300 set aside, according to a release. Read Fidelity Reports Record Gains For 401 (K) Savers Since 2009 Market Low.
To be fair, Aon Hewitt’s study does not reflect savings or other retirement assets outside of the employer-sponsored plans, which is where many people also save for retirement. And for some, the amounts saved in an IRA could make up some of the 2.2 times pay shortfall.
For instance, the total average IRA account balance in 2011 was $70,915, while the average IRA individual balance (all accounts from the same person combined, since many individuals own more than one IRA) was $87,668, according to a report released this week by the Employee Benefit Research Institute (EBRI).
But there is one more caveat. The 2.2 pay shortfall applies only to Aon Hewitt refers to as full-career contributors, workers who have 30 years of employment and contribute to a 401(k). Other workers, those who don’t contribute to a 401(k), face a 10.8 times pay, and all employees face a shortfall of 5.3 times pay.
What can you do to improve the outcome?
So what can the average worker do to make up the nest egg shortfall if they have one, and assuming they don’t want to reduce their standard of living in retirement?
First, save more. Those who save 17% of pay, reflecting a combination of employer and employee contributions, will have adequate retirement income, according to Aon Hewitt. Currently, workers contribute on average 7% to 8% of pay to their 401(k).
But even if you’re not saving that much, saving 1% more will make a big difference. Also consider signing up for auto escalation if your plan has that option.
Second, seek out advice either from within or outside the plan. A recent Aon Hewitt and Financial Engines study, for instance, showed that employees who take advantage of investment help can increase returns by as much as 2% or 3%. And Aon Hewitt’s Real Deal study shows that just a 1% difference in future return on assets can increase retirement nest eggs by two times pay. If you can’t or don’t want to use an adviser, consider the need to invest wisely. Don’t, for instance, invest in both target date funds and other funds that might negate your efforts to allocate your assets properly.
Third, retire later. Aon Hewitt’s Real Deal research analysis shows that deferring retirement to age 67 allows almost 50% of employees to have an adequate retirement vs. 29% of employees are able to have an adequate retirement when retiring at 65.
And fourth, consider carefully how you plan to draw down your assets in retirement. Aon Hewitt reports that a “retiree self-managing the distribution of their retirement assets will likely need to plan for a period longer than the average life expectancy or they will face a 50% risk of running out of money.”
To cut the risk from 50% to only 20%, Aon Hewitt reports that an employee must save an additional 2.4 times pay, which would cover roughly six additional years in retirement.
And fifth, consider a lower standard of living in retirement.
Other factors to consider
As with all things having to do with retirement planning, much depends on your income. For instance, workers will need to replace on average 85.1% of their pre-retirement income retirement. But that ratio does vary based on the amount of your pre-retirement income, according to Aon Hewitt.
Income replacement ratio: For instance, those who need $30,000 will need to replace 98% of their pre-retirement income in retirement (42.6% of which will come from Social Security, while 57.3% will come from other sources); while those who need $50,000 to $99,999 will need to replace 83.3% of final pay (38.5% of which will come from Social Security and the remainder from other sources); and those with pay of $150,000 of more will need to replace 84.2% pre pre-retirement income (15.7% of which will come from Social Security and the remainder from other sources).
Social Security: Another factor to consider is this: Social Security represents on average 4.9 times pay for the average worker, but in reality is provides anywhere from 2.3 times pay for those with income of $150,00 or more to 7.2 times pay for those with income of under $30,000. And the amount could represent anywhere from less than 25% to almost 50% of total projected needs for employees at various income levels.
Health care: On average, an employee needs about 4.5 times pay at retirement to pay for unsubsidized retiree medical coverage, or close to 30% of total needs, according to Aon Hewitt. That amount, by the way, is roughly the value of one’s income from Social Security. But Aon Hewitt reports that the impact of retiree medical on retirement needs varies significantly across the population based on pay and age, with the additional medical cost in retirement adding more to lower-income employees’ retirement needs than it does to higher-income employees’ needs.
Retirement risks: The other factors that influence whether or not you might have a shortfall or surplus in your nest egg and how large that shortfall or surplus might be have to do with investment risk, longevity risk, inflation risk, your retirement age, and your savings. So, for instance, Aon Hewitt’s baseline scenario assumed a 7% pre-retirement and 5.5% post-retirement annual return. But if returns are even 1% less, the short fall rises from 2.2 times pay to 4.3 times pay.
In addition, Aon Hewitt’s baseline scenario assumes an employee has adequate retirement income when they have enough retirement resources to last for an average lifetime—an age in the high 80s, at the 50th percentile of life expectancy. But if you increase the baseline to the 80th percentile of life expectancy, the shortfall rises from 2.2 times pay to 4.6. And the same holds true for inflation. If you increase the baseline scenario used, 3%, to 4%, the shortfall rises from 2.2 times pay to 4.7.
What to make of all this? In short, this: Crunch the numbers to determine if you have 11 times your final pay set aside for retirement. If not, do what you can to get there.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. Learn more about Retirement Weekly here. Follow his tweets at RJPIII. Got questions about retirement? Get answers. Email firstname.lastname@example.org.
To Your Successful Retirement!
Michael Ginsberg, JD, CFP®