Do You Have a Retirement Parachute?
From 1974 to 2004, the percentage of Americans covered by an active defined-benefit pension plan shrank from 44% of the workforce to 17%. Today, more that 60% of workers are employed by companies that offer new hires only a 401(k) plan, a savings scheme originally intended to complement traditional pensions, not replace them.
Nobody reminds you that what matters most isn’t the stock market’s quarterly report card, but whether your account is on target to provide adequate retirement income.
The custodian that manages your money is not required to note that, if you’re not covered by a defined-benefit plan, your 401(k) should equal at least 10 times your salary right before retirement. If you’re earning $100,000 at age 65, a $1 million nest egg isn’t a windfall; it’s a necessity. Even more improbably, a 65-year-old making $40,000 a year ought to have accumulated $400,000.
By any reasonable reckoning, fewer than 20% of Americans working today in the private sector will be able to retire comfortably. The average head of household aged 62 to 65 has only about $110,000 in combined 401(k) account and rollover IRA balances – not even twice the median salary around $61,000 for that age group. Adding to the pain of near-empty nest eggs is the fact that the income taxes on the portion of salary contributed are postponed until retirement – when folks can least afford to pay them.
The 2006 Pension Protection Act allows employers to automatically enroll new hires at a 3% contribution rate, regardless of their age – a rate that’s less than one-third of what they need to save at age 25, assuming a typical employer matching contribution rate of 3% of pay.
Waiting until age 35 to start retirement savings increases the required contribution rate to more than 17% of pay; waiting until age 40 boosts the needed savings rate to more that 23%. A worker who starts saving at age 50 ought to be putting away nearly half his paycheck. Such contribution rates exceed the legal maximums for tax-deferred saving; besides, they are simply impossible for just about everybody. Keep in mind there are non qualified alternatives that have no contribution limits and produce 50% more net spendable income than 401K plans.
Of course, there’s lots of shame to go around. While the Pension Protection Act of 2006 made it clearer that 401(k) fund advisers can advise participants on which funds to invest in, it didn’t require anyone to provide advice on what contribution rate would be prudent.
Workers and employers must create a bipartisan dialogue on retirement. The pension paternalism favored by the Democrats has failed because pension regulations make the requirements so onerous that few companies want to start or continue a defined-benefit plan. On the other hand, the Republicans’ tax-break approach to retirement savings has failed because people haven’t responded to savings incentives. But… it is not the fault of either party, rather, most Americans have their heads in the sand in setting aside money for retirement. Then, when the crisis comes these same people demand of the government to bail them out.
Oh dear…. discipline or regret!