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April 28, 2008
Scott Thole, HORAN
Americans are becoming increasingly worried about saving for their retirement, especially as the countries economic outlook continues to get worse, according to a new survey of workers and retirees. Only 18% of workers polled were very confident about saving enough money for a comfortable retirement, according to the Employee Benefit Research Institute's 2008 Retirement Confidence Survey down from 27% the year before.
Many Americans feel they can depend on Social Security to see them through their retirement years. While Social Security has played a large role in the past, the future, without changes, looks to be different. In 2017, the cost starts to exceed the income and Social Security will have to tap the interest on trust fund assets to cover benefits. In 2027, taxes and interest will fall short of annual benefit payments, so the government will be required to draw down trust fund assets to meet benefit commitments. The trust fund will be exhausted in 2041.
There are three primary ways to fix Social Security: increase taxes, cut future benefits or raise the return on Social Security's investments.
Increase Taxes. According to the 2008 Annual Social Security Administration Trustees report, Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase of 14 %in payroll tax revenues (from 12.4% to 14.1%) or an immediate reduction in benefits of 12% or some combination of the two. To bring Social Security into actuarial balance past the 75 years an immediate increase in payroll tax revenues of 26% (from 12.4% to 15.6%) or an immediate reduction in benefits of 20%, or some combination of the two would be needed. Another alternative would be to raise the ceiling on wages subject to the payroll tax.
Cut Future Benefits Benefits cuts come in forms ranging from lifting the retirement age to altering the formula used to calculate benefits.
Tax increases and benefits cuts do more than narrow the gap between Social
Security's income and outflow. They also increase the nation's total savings, the amount set aside by households, business and government.
Raise the Return The third option is increasing the investment returns on Social Security assets -- either by shifting the government-run trust fund from low-yielding government
bonds to stocks or by allowing individuals to do the same in individual accounts
alongside Social Security. A lot of controversy surrounds this solution; many feel this would increase risk to an unacceptable level.
Workers may also be basing their retirement plans on unrealistic estimates about how much they will spend after retiring, according to the Employee Benefit Research Institute's 2008 Retirement Confidence Survey.
The survey found that 58% of workers think they will spend less money in retirement than they do while working. However, only 46% of retirees said that was the case, and 54% said they were more concerned about money now than they were at the beginning of their retirement. The biggest challenge in retirement is paying for healthcare. The survey showed that only 34% of workers expect to collect employer-paid health insurance after they stop working, down from 42% last year, as more employers eliminate health care for future retirees. That percentage will probably continue to drop.
Historically, financial advisors suggested that you need at least 70% of your pre-retirement income in retirement. Based on Aon and Georgia State analysis of retiree spending habits, the 1997 survey had an average replacement ratio of 70%. Since 1997, there has been a shift in tax policies and spending habits, it has shifted the replacement rate higher than 70% (closer to 80% for the average American). Based on their 2004 study, they calculated the following replacement ratios:
Pre-Retirement Income Replacement Ratio
$20,000 89%
$40,000 80%
$60,000 75%
$80,000 77%
$150,000 85%
$200,000 88%
Employee Benefit Research Institute's 2008 Retirement Confidence Survey
The studies have shown you need less than 100% of your pre-retirement income for many reasons including:
- FICA (Social Security and Medicare) taxes do not apply to retirement income
- Savings for retirement has stopped
- Certain work expenses have decreased (some transportation, food and clothing costs) while other expenses have increased such as vacation and entertainment
- Federal & State taxes are typically less due to:
- Post-tax savings has already been taxed (other than capital gains and interest income)
- Additional deduction for being age 65 or older
- Social Security income is not taxable if your income is below a specified limit
- Some states like Florida do not have income taxes
However, because your specific situation may be different due to having a higher pre-retirement savings rate or more income coming from a 401(k) accounts which are taxable, one should calculate the exact amount that they will need as they get closer to retirement. One person may need less than 70%, if they were saving 20% before retirement and move to a state with low state taxes, while someone else may need or want 90% or more, if they want to take extra vacations or want to help their grandchildren's college fund.
So how do you know how much youneed to save for retirement?
The first step is to know how much you are going to get from Social Security and your company's pension plan if available. With Congress discussing changes to Social Security, this is not an exact science. Below is an estimate of the current benefit (for someone retiring at their Social Security retirement age) for a single retiree assuming a full working lifetime with stable earnings. If you take the benefit earlier (or later), the replacement ratio will be less (or more). If married, the spouse would get the larger of his/her Social Security benefit (based on his/her earnings or 50% of the retiree's benefit) at his/her Social Security retirement age.
Difference for
Pre-Retirement Social Security Aon's Difference for Married Retiree
Income Replacement % Study Single Retiree (spouse gets 50%
of retiree's SS)
$20,000 52% 89% 37% 11%
$40,000 41% 80% 39% 19%
$60,000 34% 75% 41% 24%
$80,000 28% 77% 49% 35%
$150,000 16% 85% 69% 61%
$200,000 12% 88% 76% 70%
Employee Benefit Research Institute's 2008 Retirement Confidence Survey
The more you earn, the more you will need to save because the smaller benefit you will get from Social Security. In addition, due to changes coming from Congress, the benefits from Social Security may be reduced, especially for younger workers. The reductions will probably have a smaller (if any) effect on older and lower income Americans and will have a larger effect on younger and higher income Americans.
Many companies are no longer offering a traditional pension plan to their employees, coupled with the probable reduction in benefits from Social Security; workers will be responsible for planning and saving for their retirement. The 401k plan and similar employee driven plans have become the primary vehicle for retirement savings and many corporations are becoming increasingly involved in getting their employees to save for their retirement. Many plans now offer automatic enrollment and automatic deferral increase to get employees started in the right direction. Lifestyle and target date funds are making the decision where to invest their money easier. These companies may no longer offer a pension plan but are taking a similar approach to setting up the 401k plan for their employees.
This article is intended to be educational in nature and does not constitute legal advice.
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