Income in Retirement: Aim for Your Target

Retirement-planning solutions tend to focus on which savings vehicle or asset allocation mix will be most effective, while sidestepping the elephant in the room: Americans do not save enough during their working years, leaving most people unprepared for retirement. Americans savings are often insufficient to fund even a portion of most future retirees’ expected lifestyles.

Most qualified plan participants determine how much to save for retirement based on the amount of income they can afford, or are willing, to defer. Next, they consider maximizing their company’s matching contribution if they are fortunate enough to have one. But aside from these initial decisions, consumers usually never change their savings rate except, possibly, to decrease the percentage deferred.

Study results released by Employee Benefit Research Institute earlier this year found “47% of Americans today between ages 56 and 62 would run out of funds necessary to pay for basic retirement expenditures if they retire at 65.”

Many people in this group believed, or still believe, an 8-9% annual return on stocks was a given, but this has not been the experience of the last decade – during which the U.S. stock market remained essentially flat – and there is no reason to suspect the shortfall will be corrected via above average performance over the next one.

As a result, there are two realistic options for savers to address their shortfall:

  • Project the amount of money needed at retirement and then determine how much savings will be needed between now and then
  • Work longer

How do we determine how much to save?

The first question to answer is “What income will you need at retirement?” Russell Investments refers to this as your Target Replacement Income rate, or TRI for short. TRI for a person making $80,000 the year before retirement who wants to receive $64,000 per year once he or she retires has a TRI of 80% ($64,000/$80,000 = 80%).

According to Russell, there are shortcuts that can help future retirees factor how much they should save in order to maintain a high probability of reaching their savings goals. The basic savings rate, which applies to a new retirement saver, is called the TRI 30 (Target Replacement Income rate multiplied by 30%). Saving 30% of TRI, including an employer contribution, leads to about a 90% probability of reaching TRI at age 65.

Our initial example used a TRI of 80%, so the required savings rate for this person applying the TRI 30 rule would be 24% (80% x 30% = 24%).

Most workers do not approximate this level of savings at any point during their working life, much less on an annual basis. Vanguard’s How America Saves 2011 placed the average participant savings rate within Vanguard sponsored retirement plans around 7%, far from the rate we calculated in our example.

Of course, this disparity is mitigated if the future retiree is fortunate enough to participate in a pension plan from state, federal or private enterprise to help offset the savings shortfall. Unfortunately, workers with expectations of pension income are a small and dwindling group.

If a future retiree can save at the TRI 30 level and pay all of their current bills, another accolade is warranted. Regretfully, these folks are similar in number to those with guaranteed pensions. There are not many who can afford to save 20% to 25% of their income on a consistent basis. Research highlighted in JPMorgan Chase’s Fall 2011 edition of “Journey” found many participants are not only not saving enough, but are putting retirement savings on the back burner altogether in favor of near-term responsibilities such as paying monthly bills and credit card debt.

We are in the midst of an economic crisis to rival those of the last century with historic levels of home foreclosures, unemployment and, according to the U. S. Census Bureau, the largest number of Americans surviving at the poverty level since the 1950s. More than 40 million Americans, with little or no assets, are completely dependent upon the benevolence of the government, family and friends. No one wants to be in this situation, but given its scope, how do we begin to remedy?

Americans must change their mindsets regarding retirement. Life expectancy has increased by about 18 years since the 1930s. Instead of needing income for three to five years, retirees now face a horizon of 15 to 25 years or more. Social Security cannot provide the whole difference.

The solution requires most people to remain part of the work force longer. Retiring at 62 is not possible for most Americans and 70 or 75 will prove a more attainable retirement age. A later retirement date will provide a longer time frame to achieve TRI.

The federal government needs to increase the age when Social Security can be drawn to 70 or older. If the birth date of Americans impacted is 1960 or afterward, they will have time to prepare. The amount of money saved on Social Security benefits would be massive. This plan could gain support from Americans who understand how making such a change will benefit their children, grandchildren and the generations to follow.

The bottom line is those who can save at the TRI 30 rate will be in a position to control their own retirement destinies. Fewer still can rely on pension income to satisfy the cost of retirement. But most should consider the likelihood they will have to work later in life than expected.