As always, someone at work brought up an interesting article/blog that they have read about one topic or another. This one is about retirement (savings) and American's attitude towards it.
Given my personal experiences over the past few years, I have taken a personal (and somewhat scary) interest in this subject.
Why?
In 2009 (at the age of 55), my mom was diagnosed with a "slow growing" cancer that turned out to be not so slow and died not so shortly after. I researched the best doctors and cancer facilities for this rare form of cancer she had, but due her limited insurance coverage & lack of funds, they wouldn't accept her into their facilities. When she finally went on to heaven, less than 6 months later, there were no funds to bury her and give her a proper funeral, there were no funds to help maintain the lifestyle of her barely-legal baby boy, who had just graduated high school less than a month earlier.....and most importantly, there were no funds, while she was alive, to either supplement her insurance so that she could get better care and/or at least funds to allow her to live out the remainder of her life in a place where she was comfortable.
A year or so later, my grandma was diagnosed with cancer. She was well beyond retirement age and was living off of her social security, struggling every month to make ends meet. Thankfully when she got really sick (however much annoying it was, I also consider it a blessing and a testament to the type of person she is/was), she had more than one of her children fighting over which one of them she would stay with. Her eldest living daughter got a bigger apartment and moved my grandma in. Still, it was a struggle financially, but they were able to make it work. When she passed (family selfishness aside), she had monies saved through insurance policies that were able to be used to pay for her funeral.....as well as a little extra that could've (note on could've) been used to supplement the rental costs of the home her eldest daughter had moved into in order to take care of her mother.
My dad has worked in sales most of his adult life. He's good at it and has been able to make a pretty penny off of it for many years of his life. Now, his health is dismal. He has major heart issues that sometimes keeps him in the hospital for days at a time. While I don't think his line of work allows for "paid" medical leave, I do believe that he was somewhat smart with his savings, so is able to maintain his bills.....despite it likely being a bit of a struggle and stretch. At the current moment, he is deciding what the best decision, as far as retirement goes. He has retirement savings put away, it's just a matter of if he wants to let it grow some more or start the process of withdrawals now. If, God forbid, something happens, his wife (who is disabled from a car accident years ago) will at least have funds to pay for all of his funeral expenses and to live off of for some time.
Lastly, today marks the day that my mother-in-law will be released from the hospital/re-hab center (yay!). Several years ago (before I even met my husband) she stopped working due to sickness related to her sickle cell anemia. Some years after that (and I'd like to think I played a part in this), she was able to get on disability and subsequently get her own apartment. A few years later, 1 1/2 years ago, she suffered a minor stroke, mainly due to improper eating and lack of exercise. A few weeks ago, my husband went to visit his mom after work and drop off some waterproof pads (a whole other story). When he arrived, he found her laying on the floor between the kitchen and the livingroom. She had fallen...... three days earlier..... hence the hospital/re-hab admission and subsequent release. In addition to the release date (which is a blessing!), today she will be staying with us until my husband can find a viable solution to her current living arrangement (living alone with only the occasional visits of her sons and other family members.....mainly my husband). This is not conducive to her current health condition and cannot continue. As it currently stands, there is only medicaid and a monthly disability check. There are no savings or retirement money that can be used to make sure she gets the proper care needed. She is basically at the mercy of the state (who may have programs to supplement the cost of elder care) and her medicaid (which can be used for limited coverage options).....and her children/family.
Living through all these situations make me very aware of how important savings (including & especially retirement savings) actually is. While the money is set aside specifically for retirement, it can be used at any time and penalties can be avoided if the money is being used for purposes, such as sickness, education, your first home, birth of a new child, marriage, etc. Also, it can also serve as an additional form of life insurance, if you die before your expected time.
Retirement: The Scary Numbers Behind The Soothing Lies
The state of Americans' retirement accounts is dismal is how ConvergEx's Nick Colas begins his critically important-to-read note on the reality that millions face. According to an early 2012 study by the Employee Benefit Research Institute, Colas notes only 58% of us are currently saving money for retirement – and 60% of those that are have less than $25,000. Thirty percent have less than $1,000. Needless to say, it's a far cry from the 8x-10x final earnings suggested by most retirement planners. So why are we so far behind? Americans aren't exactly known for impressive savings habits, but that alone does not explain our poor preparation for retirement. Rather, a general lack of financial literacy, including basic understandings of savings growth and retirement income needs, superseding financial obligations, and basic behavioral finance biases keep us from putting cash away. But if we keep up at this pace, you can expect the ongoing political debate about Social Security to take on new and more strident tones.
Via Nick Colas (and Sarah Miller) of ConvergEx: Hope I Die Before I Get Old
Note From Nick: I don't remember anything about being 23. Or 24. Or…, well, you get the idea. But understanding the financial decision making of this cohort is a useful exercise, especially when it comes to investing for retirement. Happily, Sarah is in the thick of these decisions and is, in fact, 23. It is pretty easy to see the long shadow of an important social problem from her narrative. If you think the debate over Social Security is raging now, just wait a few years. And now, over to Sarah…
I've been at ConvergEx for just over a year now, and I'm happy to say I've survived 12 months at my first job in the "real world" after college. I'd like to think I'm a bit smarter than I was when I walked in here last year. When I was given the employee handbook with all the options for healthcare, restaurant discounts, and pre-tax transportation contributions, I admit I had no idea what to choose. So I did what any 22-year-old Millennial child would have done: I called my parents. I figured my mother, who works in healthcare, and my father, the finance professional, would be the best advisors for these kinds of decisions.
After deciding on my options for healthcare and transportation, we finally came to the 401k – something I had certainly heard of, but never really confronted. At 22, retirement savings was nowhere near the top of my priority list; and having just moved into New York City, I was not keen to tuck away part of my paycheck that could have been redirected towards some other expense. After all, wouldn't that money serve me so much better as a new pair of boots than it would in some account? Part of me is still inclined to say "YES!". But knowing my parents probably knew more about this than I did, I followed their advice and put a whopping 1% of my paycheck towards the 401k.
Little did I know that only one year into my employment, at the age of 23, I would be farther ahead in my retirement savings plan than millions of American workers. According to a March 2012 survey by the Employee Benefit Research Institute for "retirement confidence", the majority of Americans are vastly underprepared for retirement, with very few savings or even none at all. A few key takeaways from the report, which can be found here:
- Only 58% of us are even saving for retirement in the first place. Of that group, 60% have less than $25,000 put away, not including home equity or defined benefit plans. Even worse, a full 30% have less than $1,000. A meager 10% have $250,000 or more. (For comparison's sake, a quick survey of different retirement advisors' websites showed that the average recommended savings is about 8x-10x final salary – by some estimates, around $1 million)
- While these low savings might be expected of the youngest age cohort, almost half (48%) of workers ages 45 and up have less than $25,000 saved.
- Savings rates and the amount saved are strongly positively correlated to education, income, and health status. 93% of those making more than $75,000 are saving, compared to 35% of those with and income of $35,000 or less.
- Only 38% of all American workers participate in an employer-sponsored retirement savings plan. That said, only 74% are offered this kind of plan. Of those that choose to participate (81%), savings and investments typically total at least $50,000.
- 34% of workers that had saved said they have had to dip into their savings to pay for everyday expenses. 22% of retirees claim they're taking more than they thought they would out of their accounts, depleting their savings even faster than they anticipated.
- Overall it's a pretty bleak picture. On the whole, Americans are hugely underprepared for retirement, leading quite a few of them (22%) to put off retirement to a later date, or not retire at all (7%).
With these obstacles in place, it's not necessarily shocking that Americans are financially underprepared for retirement. More financial planning education, or at least a simple demonstration of the importance of saving, and clear options to all workers may help to better prepare us. But a close look at what we expect from our retirement plans – both in the public sector and the private – is essential, given a general misunderstanding of savings growth and payouts on both ends. It's up to individuals in the private sector to make our own changes, but public sector pensions face quite a host of litigation and regulation to push through.1. Lack of financial literacy. Americans on the whole are not versed in the ways of financial planning. A study by Lusardi and Mitchell in 2005 found that less than half of a sample of US adults 50 and older was able to answer simple questions about inflation and compounding interest. Another study, by McKensie and Liersch in 2011, showed that a majority of adults misunderstood savings growth: they expected it grew linearly rather than exponentially, therefore underestimating the potential return a small investment could have over several years. When exponential growth of savings was demonstrated, real employees chose to save more for retirement (see the study here). To top it all off, 34% of those surveyed by the EBRI estimated they needed less than $250,000 to retire.
It's plain correlation, here – the more you know about retirement planning, the more likely you are to do it. Most Americans don't even calculate how much they might need, leading them to grossly underestimate the costs. A good portion of them (79%, according to the EBRI) also think that Social Security will be a dependable source of income during retirement – much more so than retirees in the 20th century. While that may be true for the Baby Boomers, my generation can't bank on SS being there when we turn 65. Instead, it's important that we understand the importance of saving for retirement – or, more likely, the risks of not doing so.
2. Basic behavioral finance biases. Much like the typical stock market investor, retirement savers face several obstructions in the way of their savings goals. A short report from the 2010 Social Security Bulletin, found here, highlights a few of these.
"Ambiguity aversion" is rampant: investors don't trust products they don't understand. Given the lack of financial understanding of retirement accounts, then, it's not surprising that so many Americans shy away from them.
"Heuristics bias" is another classic behavioral finance term found in retirement savings literature. Even if we do choose to save, we may not follow the so-called "rules of thumb" that classical economics assumes in retirement accounts. For example, the traditional allocation shift from equity to bonds as one ages is assumed in classical finance, but according to a 2009 study by VanDerhei, quite a few older investors did not follow this "rule" and lost a significant portion of their savings in 2008.
"Hyperbolic discounting" is also to blame. This is the theory that we sacrifice long-term large gains for short-term immediate gains – we'd rather have an extra $20 in our pockets every month than in an account we don't touch. This will be a tough one for Americans – the chronic spenders – to overcome.
3. Superseding financial obligations or situation. From weekly groceries to college tuition, savers today are putting other financial obligations ahead of their retirement plans. According to the EBRI survey, 62% of workers consider their current level of debt to be a problem, and may choose to allocate more spending to paying down that debt than to saving for the future. Lower income households are especially prone to this problem: with less income to put away, fewer and fewer of them are saving (down to 35% in 2012 from 49% in 2009).
4. Options. While employer-sponsored retirement savings plans yield high participation rates and above-average savings, not all workers are fortunate enough to have this option. Defined contribution plans such as 401ks and IRAs have overtaken defined benefit plans in the private sector: according to a Department of Labor report from March (found here), a peak of 175,143 private pension plans existed in 1983. That number is now down to 47,137. And as various retirement account studies show, "opt-in" retirement accounts do not draw as many participants as "opt-out" – a clear explanation for Americans' under-preparedness. This has prompted a few researchers to suggest more active advertisement of plan options for those both with and without employer-sponsored plans to facilitate higher response rates from employees.
The public sector, meanwhile, is still in relatively good shape in terms of defined benefit plans. But while state and local public employees near retirement might expect a decent payout when they become retirees, plans may have to change for public sector employees in the future. Many states – California and Illinois in particular come to mind – have started to consider changes to pension plans given massive cash shortfalls and, arguably, overestimation of growth potential in the pensions (to see a list of expected growth rates in public pension plans by state, see here). Some localities, such as San Diego, have already switched city workers over to defined contribution plans instead.
Most of all, it's concerning that so many Americans seem to think Social Security is a dependable enough program to fund their retirement. The average payout for a retired worker in August was $1,235.63 – hardly enough to sustain oneself through several years of retirement. My generation will need to come to terms with the fact that by the time we retire, SS may simply not be around. But those who are approaching retirement in the near future need to understand – and plan on the fact – that Social Security cannot be their only source of income in their retirement years. They need to start saving, and fast.
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