As important as retirement planning is, most Americans do not give their retirement the proper amount of attention. Why not? Is it the sunny optimism of most Americans that things will work out somehow, a downplaying or misunderstanding of the importance of financial planning, being overwhelmed by the concept, or simply an assumption that they will be covered by Social Security?
A recent strategy paper by The Hamilton Project addresses these issues in some detail by issuing facts about retirement planning and placing them in the context of three categories: current retirement challenges, savings habits, and future challenges. Let's look at those categories in more detail.
The Challenges of Preparing for Retirement
Excessive optimism does not appear to be the problem. Only half of Americans believe they will have sufficient funds to live comfortably in retirement, and that is likely for two reasons: we are living longer and approximately half of retirees will have to pay for long-term care services out-of-pocket.
The optimism does increase for those with formal retirement plans (pensions, 401(k) plans, or IRAs). Approximately two-thirds of those with plans are either somewhat or very confident in their retirement overage, compared to only one-third of those without formal plans.
Life span improvements mean that whatever retirement plans you have must last longer than in past generations. Compared to 50 years ago, the chances of a 65-year old man seeing his 80th birthday was 41% compared to 62% today, and the chances of his reaching 90 have more than doubled.
It may be that seniors are underestimating today's expanded life spans and the corresponding increase in the need for long-term care services — as well as the staggering cost. The ratio of costs for long-term care in 2013 was $59 billion in out-of-pocket costs and $25 billion in insurance costs. Half of Americans are expected to incur out-of-pocket expenses for long-term care, while only around 13% of seniors aged 65 or older have any long-term care insurance at all.
How Americans Save for Retirement
The nature of retirement programs has shifted dramatically over the last few decades from traditional defined-benefit pensions into defined-contribution programs like 401(k) plans and IRAs. Businesses have shifted the costs and much of the responsibility for retirement onto individuals. There are varying levels of engagement among retirees. Defined-benefit programs bring the possibility of greater returns at the risk of significant losses and a requirement that people pay more attention to their plans.
Another variable is the housing market. For the middle-class, the value of their homes tends to be near the value of the retirement accounts. The share of those two assets are squeezing out the traditional amount of stocks, bonds, and cash — leaving the middle-class with more volatile and less liquid assets heading into retirement compared to the pensions of old. Compound this with a growing gap in wealth between upper and middle classes, and it makes retirement planning even more daunting for the less wealthy.
Challenges for the Future
There are three major facts listed by The Hamilton Project as future challenges to retirement planning:
- Fewer Workers, More Retirees – Longer life spans and the retirement of the larger Baby Boomer generation will be straining the Social Security system. Its share of the federal budget was 13.4% in 1962 and 23.5% in 2014 — and the boomer generation is just starting to retire. Without action to increase revenue, by 2033, benefits will have to be reduced by around 23%, and the collective US debt makes this action increasingly difficult. Translation: Social Security is likely to be around, but expect fewer benefits.
- Tax Code – The tax system contains many incentives for retirement savings, especially to increase employer contributions to plans. However, most of these incentives help those who already have done their financial planning and hold retirement accounts. The top 20% of the income distribution takes approximately two-thirds of these tax breaks. Poorer and less financially literate Americans see fewer benefits, which leads to the final point.
- Poor Financial Literacy – Far too few Americans understand basic financial information necessary to plan their own retirement, such as budgeting, risk assessment, the time value of money, and even compound interest.
To paraphrase Donald Rumsfeld, they "know what they don't know" and seek financial advice. Unfortunately, without financial literacy, it's too easy to be steered into financial products that benefit the adviser more than the advisee. That's why the Obama administration has proposed rules to hold brokers to fiduciary standards, holding their client's interests ahead of their own.
In short, retirement planning is made more difficult today by its complexity in terms of increased individual responsibility, greater options, and the need for greater financial literacy to understand those challenges and options.
Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.