Retirement Savings-Personal Responsibility Time

I saw this article in the WSJ last month, and meant to write about it -- luckily, Megan McArdle did as well! Basically, in a nutshell, the article discusses that many boomers getting ready for retirement have nowhere near enough saved. There are plenty of examples of ignorance or greed at work:

Gloria Moss has been contributing to a 401(k) since 1985, when she went back to work after having children. Especially after divorcing, she wasn't able to contribute as much as she wished and when her children finished college, she focused on repaying college loans. She says she lost more than half her savings in the recent financial crisis, then shifted heavily to bonds and missed the stock rebound.

Mistake #1: Don't pay for kid's college over your own retirement, unless you plan on making those kids support you in your old age. The kids have plenty of time to pay down reasonable student loans, and there are scholarships available to offset the cost of school, as well as less expensive options (like two years of community college, then a transfer to a state school; or ROTC...). Mistake #2: Don't sell at the bottom in lock in your losses! She sold all her equities at the stock market crash's bottom. If she had a "buy and hold" strategy in simple "Lifecycle" style funds she'd have been much better off. For some reason, people will make snap, emotional, and uninformed decisions about the biggest asset they own (their retirement account) without actually doing any research.

Just 8% of households approaching retirement have the $636,673 or more in their 401(k)s that would be needed to generate $39,465 a year.

That's probably because for some reason, people assumed they could contribute 5% of their income to retirement savings and then not work for 30 years. I mean, the idea that you can spend 20 years in school, work for 40 years, then retire for another 30 means that you'd be working less than half your life. To sustain your lifestyle in retirement, even with the magic of compound interest, you'd need to save significantly more than a 5% IRA contribution with employer match.

In 2008, when he was 59, John Mastej figured he was on track to retire in his early 60s. He and his wife both were working, with 401(k) plans. Counting all their savings, they had close to $200,000. Mr. Mastej was putting 20% of his salary into his 401(k)... They buy some food at discounted prices through their church, but are proud they have remained current on their mortgage, home-equity loan, insurance and property taxes.

This man is justifiably proud of contributing 20% of his salary to a 401K, but apparently didn't have his house paid off. I have a sneaking suspicion that at some point, he used his home equity like an ATM and cashed in on a paper gain in housing prices. At retirement age, there's no reason why you can't have a paid off property. You can't cash out the equity in your house, then be proud of contributing 20% to an IRA. That's like being proud of saving for a Vegas trip before you leave, but running up a huge credit card bill in the meantime.

Carol Dailey is continuing to work at age 71. Ms. Dailey spent 10 years as an executive assistant at America Online and had stock options she figures were once worth $1.7 million. The options' value collapsed with the company's stock.

Diversify. Anyone who has all their eggs in one basket is at risk of making an omelette. If she had cashed out her options and put them in a simple Lifecycle fund she'd be fine.

You can look at a simple retirement calculator to see what sort of savings are needed. If you are truly of modest means, and sock away $2K each year to maximize your Federal Saver's Tax Credit (basically a 50% match by Uncle Sam), then at 8% you'll have about a million dollars (a quarter of a million after inflation) after 42 years of work. That's not much, but if you also own your house outright, and you live in a low cost part of the region, that might be doable.

If you max out your ROTH IRAs every year ($5K), you'll have $1.5M ($423K after inflation). Those are pretty healthy numbers, significantly healthier than the average balance in people's 401Ks. If you max your IRA every year and own your home outright (i.e., you've been paying the mortgage instead of treating it like an ATM), then you should be around the ~$650K target number. And that's for a single wage earner! Obviously, a two-income couple would be able to sock away much more.

This tells me that most Boomers have been using their houses as ATMs, didn't start saving until late in life, and when they did start saving, didn't max out the tax advantaged vehicles available to them. That is, they preferred to spend lots of money on nice toys and the good life than to sock away money religiously for the future, and now, they'll be counting on social security and medicare--only to find that politicians have been no more responsible than they have in funding retirement obligations. It is cruel but apparently true.

The other factor I haven't hit on is inflation and taxes. If you mess around with the calculator, you'll find that increasing taxes by a bit (say, state taxes) has a major impact on savings. So does inflation, which effectively adjusts your rate of return up or down.

The biggest hurdles are to (A) start early and (B) save regularly. If you aren't investment savvy, max your IRAs, dump it in a Vanguard target retirement age account and forget about it. Then save a little more, too! Otherwise, you can worry about minimizing taxes and expenses, too, and get into asset allocation.