Having enough money to pay the bills should be the first thing to go when it comes to saving for retirement.

However, according to a new survey on retirement readiness, the retirement deficit – the risk of not having enough money during retirement to cover regular expenses – is greatest among baby boomers in their late 60s who have low- or medium-paying jobs.

So what’s the problem? Members of this group, who could probably live paycheck to paycheck right now, will generally need almost as much money to cover their bills in retirement as they do while working and earning a salary. According to Fiona Greig, global head of investment research and policy at Vanguard, social security checks and other forms of savings for this group of low-paid workers may only allow them to cover less than two-thirds of their pre-retirement expenses.

Many fear financial shortfalls in retirement

Millions of people face substantial deficits when it comes to living comfortably, rather than luxuriously, in retirement. We’re not talking about booking Viking cruises or taking five or six grandchildren to Walt Disney World.

It’s easy to think that your experience will be the same as someone else’s when it comes to saving for retirement, but that’s not the case. The range of traditional pensions has come a long way in the last fifteen years. And people who have not benefited from regular pay rises are seeing a greater proportion of their salary being used to cover day-to-day expenses.

One issue that came to the fore during the United Auto Workers’ controversial strike against the Detroit Three is the financial vulnerability that many auto workers feel today, as those hired in the fall of 2007 and beyond no longer benefit from a traditional pension.

I spoke to workers in their fifties who had saved $50,000 or less for their retirement – and had no pension to support them.

The tentative agreements from Ford Motor Co., Stellantis and General Motors address some of the angst and lack of savings by increasing employer contributions to 401(k) plans for hourly workers who don’t benefit from a traditional pension.

The three agreements in principle provide for a 10% employer contribution to the 401(k) plan for wages up to 40 hours a week. This represents an increase on the Detroit Three’s contribution of 6.4% of base salary for workers hired within the last 16 years or more. There is no mandatory 401(k) contribution by these hourly workers to get this money.

How much income do you need to replace in retirement?

The amount of money you’ll need in retirement generally reflects what you earn today. Often, people are given a general figure saying they need to replace between 70% and 85% of their income. That’s not a bad assumption, but it’s not the same for everyone.

Some groups now have to replace almost their entire annual income each year in retirement.

“Lower-income families have to replace a larger fraction of their income than this benchmark,” Greig said.

“Based on retirement spending patterns, we estimate that families at this income level need to replace 96% of their pre-retirement income.

“There’s not much to cut in their budget.

The working poor are defined as those earning around $22,000 in the year prior to retirement. They earn less than 75% of the general population. Their income is so low that they don’t have much to cut back on. Most of their money is spent on necessities.
According to Greig, for this group, Social Security will replace 62% of their pre-retirement income. This is a considerable sum and a higher replacement value than for higher-income workers, but the savings deficit remains considerable.

Almost 34% – or 34 cents for every dollar spent – must be replaced in some way to cover the bills, for example through employer-sponsored retirement savings plans or individual savings. In some cases, it’s even possible to sell the family home and move to a lower-cost area, if the family has accumulated equity that can be liquidated at the time of sale.

The Vanguard study shows that low-income families are often only able to save to a certain extent, and can only use their savings to contribute around 2% of what is needed to cover bills in retirement, leaving a gap of 32%.

Many underestimate how long they’ll live in retirement

Many people jeopardize their retirement by underestimating how long they can save. Underestimating potential longevity can lead you to think you’re better prepared for retirement than you are, prompting you to save less money or take the risk of retiring early, at age 50.

Then there’s the financial fatigue of dreading that your 401(k) savings will be cut in half in the next Wall Street bear market. Often, people don’t even have access to a small pension and rely heavily on their own savings.

“We don’t know exactly how long people are going to live,” Greig said, “and we don’t know exactly what kind of stock market environment people are going to experience.”
More people than you might think have nothing saved for retirement.

Some 28% of non-retired adults have no retirement savings at all, according to the Federal Reserve’s 2022 Household Economy and Decision Survey. This figure is up from 25% in the 2021 survey.

Young adults aged 18 to 29 tend to save less for retirement, as do non-retired blacks, Hispanics and people with disabilities, according to the Federal Reserve.

Some higher-income workers see a small ‘retirement gap’

Some high-income workers are seeing a slight “retirement deficit.”
The amount people will have to spend in retirement, relative to what they earned while working, generally varies significantly with income. According to the Vanguard report, for most groups, projected income in retirement is less than spending needs, but the gap is not as large as it is for low-income workers.

“The replacement rate target actually depends on income level,” said Greig.
High-income workers, for example, need to replace a smaller percentage of their pre-retirement income during retirement.

Those with an average income of $61,000 – more than 70% of the general population – must rely on Social Security to replace 40% of their income. Since they have more discretionary spending while working, they would need 68% of their pre-retirement income to cover their expenses in retirement.

Even after using their savings, notes the Vanguard report, they still face a 17% savings deficit.

In contrast, high-income earners – those earning around $173,000 a year – spend only 43% of their pre-retirement income on retirement, according to the Vanguard study. This group has much greater savings and can cover 63% of their pre-retirement income. Social Security only replaces 18% of this group’s pre-retirement income.

For many workers, the solution may lie in delaying retirement and continuing to work if possible. If they have accumulated equity in their home, they may be able to sell it, invest the money and rent it out. But this is a strategy that few people adopt.
Some public policy issues also need to be addressed.

Greig said the data provides yet another reason to “strengthen what we already have”, noting that Social Security is fundamental to the financial well-being of many people as they age.

According to Vanguard, certain innovations will be key, such as committing plan sponsors to include more non-participants in 401(k) plans and conducting “undersavings sweeps” to ensure that employees save enough to maximize employer matching of their contributions.

Starting in 2025, federal law will require companies offering new 401(k) and 403(b) plans to automatically enroll eligible employees at a contribution rate of at least 3%, but no more than 10%. Employees can opt out if they do not wish to set aside this amount of their salary.

Employers will certainly not be required to offer 401(k) plans under Secure 2.0. About half of workers in the U.S. don’t have access to an employer-sponsored plan. That’s why, says Greig, it’s important to expand access.
Retirement is not a one-size-fits-all solution, like all other aspects of our financial lives. Not all groups see their wealth increase with an inheritance, or feel secure after years of putting money aside in a 401(k).

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