Read the headlines about retirement readiness and you'd think that at least half of us had forgotten to go to class, do our homework or study for one of the biggest tests of our lives. When exam day arrives, we're totally unprepared.
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But what if it's just a bad dream and we wake up to find that we are on track after all?
In fact, researchers are suggesting that assessments of Americans' retirement readiness are too dire and that most of us are in pretty decent shape. How so? Some studies underestimate people's ability to catch up on saving after the kids are grown or overstate the level of income workers need to replace in retirement, says a report by Sylvester Schieber, the former chairman of the Social Security Advisory Board, and Gaobo Pang, of benefits consulting firm Towers Watson. Others neglect to factor in resources outside of employer-based retirement plans, such as IRAs and home equity, or the relatively high benefits that Social Security pays low-wage earners.
Part of the disconnect is that retirement benchmarks are created for large segments of the workforce rather than individuals, says Schieber. "If you're designing a plan that's trying to cover 10,000 people or even 1,000 people, you're going to have to make some assumptions about how they behave. But every household's circumstances are different." Families whose situations don't fit the assumptions, he says, "can't rely on that rule of thumb for a road map to success."
No one disputes that some portion of the population—maybe 20%—will arrive at retirement vastly unprepared. "Those are households with lower wages and lower levels of education who have struggled with basic savings skills, or people who have suffered terrible economic hardships," says Stephen Utkus, director of the Vanguard Center for Retirement Research. But overall, the black-and-white, ready-or-not assessments of past years have given way to "a more nuanced view of preparedness," he says. "You have to look under the covers—it's person by person."
Taking a closer look is key to your own retirement planning. Before you conclude that you've fallen short of the mark or that you don't dare spend an extra dime of your retirement funds for fear of running out, decide what you really need based on your own finances and expectations.
Calibrate your saving
You've probably already gotten the memo to stash 10% to 15% of your annual income (including any employer match) in your retirement account, starting with the first month of your career and ending with the last. That strategy not only lets you take advantage of the magic of compounding (a no-brainer way to build savings), but it also encourages the habit of saving and keeps your contribution level in step with pay raises. At the end of a 40-year career, you should have enough in the kitty to see you safely through a 25- or 30-year retirement.
Straightforward as the plan may be, however, it fails to acknowledge the bumps and potholes that inevitably show up on the path from young adulthood to retirement age. Kids constitute a major detour, says Schieber. "People who have a child are probably going to be consuming differently and saving differently than if they don't have children and don't intend to have children," he says. Other savings off-ramps include buying a house, paying off student debt and suffering a job loss.
How to choose between setting aside money for, say, college or a house and saving for retirement? "When I talk to people who say they are going to stop saving for retirement and start saving for college, I suggest they adjust downward, not stop," says Utkus. Easing up on retirement savings for a few years shouldn't slow you down too much if you've fueled your accounts early on.
Eventually, kids grow up, mortgages get paid off, and income rises. By the time you're in your mid fifties, you may be able to free up 20% or more of your annual income for retirement savings. And once you hit 50, you can make an annual catch-up contribution of $5,500 to your 401(k) in addition to your maximum annual contribution ($17,500). You can also add $1,000 to your IRA on top of the annual max of $5,500.
Still, keep in mind that a late-life crisis, such as a health problem or forced retirement, could affect or even destroy your ability to recoup. Letting your savings grow over time remains the recipe for retirement readiness, says Thomas Duffy, a certified financial planner in Shrewsbury, N.J. "When you make tomato sauce, you have to let it simmer. Money's the same way."
Assess your target
Retirement planners generally recommend that you have enough savings at the end of your working life to replace 70% to 85% of preretirement income. The targets take into account that you'll no longer be saving for retirement, getting dinged for payroll taxes or covering work-related expenses, such as commuting costs. To get you to an 85% replacement ratio, Fidelity recommends that you save eight times your final salary, minus Social Security and any pensions.
Some planners go further, suggesting that you aim to replace 100% of your preretirement income, on the theory that what you'll save in some categories, you'll spend in others. "Even if you're not paying payroll taxes, that cost will likely be offset by a new hobby or travel. Or if you're staying at home more, you'll want to remodel. There always seems to be something," says Leslie Thompson, a managing principal at Spectrum Management Group in Indianapolis, which advises clients on retirement planning.
But maybe your hobby involves reading by the fire, not skiing in Vail. Or maybe your mortgage will be paid off, or you'll move to an area where the cost of living is much lower than where you are now. Given that your biggest spending years are when you're raising kids, you might get along just fine with 60% of your preretirement income. A recent survey by T. Rowe Price showed that three years into retirement, respondents were living on 66% of their preretirement income, on average, and most reported that they were living as well as or better than when they were working. If you scrimp to meet a benchmark designed for somebody else, "you could be over-saving now and shorting your current lifestyle," says Duffy.
Then there's a retirement asset you are likely to have in abundance: time. Maureen McLeod of Lake Como, Pa., retired last year from her job as a professor at Commonwealth Medical College, in Scranton. Now, she says, "my husband and I don't eat out as much, by choice. At the grocery store, I shop around a little more and compare prices, so I'm spending less on food. We're not so rushed." The fresh sushi she routinely picked up during the workweek? She buys it once a week, on senior discount day.
McLeod's experience echoes research done by Erik Hurst, of the University of Chicago, and Mark Aguiar, of Princeton University. They report that people save on food costs in retirement not because they are eating less or buying hamburger instead of steak but because they have more time to compare prices and prepare meals. The time payoff extends to other activities, such as shopping for travel bargains or taking on household chores you might once have paid someone else to do.
Crunch your own numbers
To get a handle on how you'll spend your time and money in retirement, make a detailed analysis of what your expenses are now, says David Giegerich, a managing partner of Paradigm Wealth Management, in Bridgewater, N.J. He recommends starting the process about five years before you turn in your office keys. "In the first two years, don't try to clip coupons, and don't stop going out to dinner," he says. "Live your life so you can get a realistic picture of what you're really spending."
Among the obvious expenses: housing, utilities, food, gas, clothing and entertainment. The not-so-obvious? "Even if you retire your mortgage, you still have to pay property taxes and homeowners insurance," says Thompson. Other off-the-radar expenses include annual payments for insurance premiums and future big outlays for, say, a new car or a major trip. "People say, 'This is a one-time-only thing.' But there tend to be a lot of one-time-only things," says Thompson.