The Growing Challenge of Funding Retirement
In 2011, Al Horila, 64, retired from a Fortune 500 company after 30 years of service with a modest traditional pension, retiree health benefits, and a 401(k) account that he rolled over to an IRA. But new employees who follow a similar career path will not enjoy the same retirement benefits. "There was a cut-off date and new employees no longer get a defined-benefit pension," says Horila, of Ashford, Conn. "The company was bought out in 2007 and I was lucky because I was grandfathered in."
The rules for retirement have changed over the past generation. Individuals must now take more personal responsibility for their retirement finances, as life expectancies increase and job security declines.
Employer retirement benefits have become less generous over the past several decades. In 2011, only 20 percent of private-sector workers had access to a traditional pension at work that guarantees payouts for life, according to the Bureau of Labor Statistics. In contrast, 58 percent of private-sector workers were offered a 401(k) or similar type of retirement account, and 41 percent participated. While private-sector traditional pensions are typically insured by the federal government up to certain limits, 401(k) plans and retiree health benefits are not.
Individual workers are responsible for funding their own 401(k), selecting appropriate investments, and making sure that savings lasts for the rest of their lives. "If you don't contribute and invest the money safely, there won't be much of a nest egg," says Olivia Mitchell, director of the Pension Research Council at the University of Pennsylvania. "If you don't figure out how to manage your money during the retirement phase, you could run out."
Social Security benefit payouts have also been reduced over time in the form of a higher retirement age. While the age you could claim the full amount of Social Security you are entitled to used to be age 65 for those born in 1937 or earlier, retirees must now wait until age 66 to claim the full payments they have earned. The retirement age will increase to 67 for those born in 1960 or later. Payouts are reduced for retirees who claim their benefit before their full retirement age. For example, a worker born in 1962 who claims Social Security at age 65 will see his or her benefit decreased by 13.3 percent.
Employer and government retirement benefits are shrinking at a time when individuals are living longer than ever. There were 40.3 million people age 65 and older as of April 1, 2010, up 5.3 percent from 35 million in 2000, according to the 2010 Census. This number is expected to skyrocket as the massive baby boomer generation begins to enter the traditional retirement years. Upon retirement at age 66, men born in 1950 have an average life expectancy of 18.3 more years, and women born in 1950 have an average of 20.3 more years, according to Social Security Administration data. People born in 1980 can expect an even longer retirement of 19.3 years for men and 21.2 years for women, even after the higher retirement age of 67. And, of course, many people will live longer than these averages.
Most individuals will have to save on their own to supplement Social Security. In theory, it sounds simple enough to save $5,000 annually beginning at age 25, get a $1,500 401(k) employer match per year, and have just over $1 million upon retirement at age 67, assuming a 6 percent annual return. But in reality, there are plenty of goofs and gotchas that trip most people up at least once. There are often waiting periods to join a 401(k) plan at a new job, hidden or difficult-to-discern fees that are deducted from your returns, and penalties if you withdraw the money early. And, of course, that 6 percent annual return is not guaranteed -- actual returns will fluctuate considerably from year to year.
"When you look at how much money people have in their 401(k)s, on which they are becoming increasingly dependant, the money just isn't there," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "This notion that you can put in 6 percent of pay and your employer puts in 3 percent is just not right. If we're going to rely on these 401(k)s plans, we need to put in a number closer to 15 percent rather than 9 percent."
You also can't count on getting a 401(k) match from every company you work for until you retire. Employer contributions vary considerably from company to company. They're often forfeited if you leave a job before you are vested in the retirement plan, and many companies suspended or eliminated them during the recession. Jason Unger, 28, of Silver Spring, Md., was saving 10 percent of his pay in a 401(k) plan and getting a 2 percent employer match, but in 2008 his employer suspended the 401(k) match. "When mine was cut I kept saving in the 401(k) for a while, but then we had our first kid, my wife stopped working, and I stopped for a while," Unger says. Now at a new job with a 401(k) match, Unger is saving for retirement again.
Even if you manage to win the 401(k) savings game by the time you retire, all it takes is one major health problem or chronic condition to strike out. While Medicare offers significant financial protections to retirees age 65 and older, it comes with many out-of-pocket costs, including premiums, deductibles, and coinsurance. Fidelity Investments estimates that a 65-year-old couple retiring in 2011 will need $230,000 to pay for medical care throughout retirement. And Medicare generally doesn't cover services that many retirees will need such as eyeglass, hearing aids, dental work, and most importantly, long-term care. "Your current expected out-of-pocket costs under today's system are likely to be an underestimate of what is going to happen to you by the time you get there," cautions Jack VanDerhei, research director at the Employee Benefit Research Institute.
The quickest fix for a too-small nest egg is simply to delay retirement. Working a few extra years packs the triple-punch of giving you more time to save, reducing the number of years your savings must finance, and it allows you to receive larger monthly checks from Social Security later on in retirement, when you are most likely to need the money. But staying in the workforce isn't always an option at a time when layoffs are common and companies are eager to unload their most expensive employees. The other alternative is to significantly downsize your lifestyle to the point where you can live on a combination of your Social Security checks, withdrawals from personal savings, and any other income sources you have. "You simply can't live to 100 and only work for 25 years to pay for it," says Mitchell. "It's simply not possible without cinching the belt much, much tighter than most of us would want to do."
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Personal Finance - The Growing Challenge of Funding Retirement
(c) 2012 U.S. News & World Report