Addressing pessimism about retirement savings

    A reader is skeptical that 401(k)s can provide enough to live on in retirement, so we followed up with financial advisor Tom Mooney for some help. The bottom line: Savings is a sacrifice, and everyone needs to find a level they are comfortable with.

    Following a web chat about planning for retirement with financial advisor Tom Mooney, part of our series Gray Matters: New Tools for Growing Older, a reader emailed us with some concerns about relying on 401(k)s and similar savings vehicles.

    Read his email to the right. Mooney’s response follows here.

    In response to the writer’s sense of pessimism: I can understand it.

    The responsibility for ensuring an employee’s general well-being in retirement has been shifting — for a long time now — from the employer to the employee. Companies have not done a very good job of managing these defined benefit plans, which has increased their costs as a result. Companies are now seeking to minimize those costs and offload the risk to their employees.

    I recently read that Pfizer became the latest company to eliminate its defined benefit plan, i.e., pension, in favor of having employees contribute to a defined contribution plan, e.g., 401(k) and or 403(b). Unfortunately, this is not a trend that is going to reverse itself any time soon as companies focus more and more on their bottom line.

    Savings plan

    As a result of this trend, employees are going to have to take on more responsibility for making sure that they will be able to afford the retirement that they envision for themselves. This will mean taking a holistic view of their entire financial picture. This will include focusing on savings and expenses as well as what goals they would like to accomplish. This will also mean putting together a budget that will put them on the path towards accomplishing those goals. One of the key components to achieving those goals will be establishing a savings plan.

    One of the best ways to save for retirement is through a 401(k) or 403(b). For the most part, these accounts are an invaluable tool for all employees to save in a tax-efficient way, regardless of income. There are rules to ensure that these accounts don’t favor highly compensated employees so they can be used by almost all employees.

    These accounts are even more compelling when the employer matches the contributions of the employees. Oftentimes, an employee will match $1 dollar for every $1 that the employee contributes. Employees should make the necessary sacrifices to get that match, as it is essentially free money. Another benefit of the 401(k) is that it allows for more mobility as employees move from one job to another. For example, if the employee changes jobs, he can take the entire value of the 401(k) account with him.

    By the numbers

    It can seem impossible to rely on a retirement account, but Mr. Savage’s math doesn’t take into consideration compounding, which, as Einstein said, “Is the most powerful force in the universe.”  

    The example I would use is someone who was making $50,000 per year and saving 10 percent (5 percent from himself and 5 percent from the employer) into an account that earned 8 percent per year. He would have $726,000 (in today’s dollars) in his account at age 65 if he started working and saving at age 22. I am also assuming 3 percent inflation.  

    If you withdraw 4 percent from that account per year, you have $29,000 to live on per year. You can add that to your spouse’s money, if you’re married. You can also factor in Social Security, and some people will have a pension. 

    Savings strategy

    A 401(k) or 403(b) is just one component of a savings strategy, and this saving cannot be done in a vacuum. Most people would benefit from having a written financial plan that takes into consideration all of one’s goals, expenses, incomes, etc.

    A 2011 Wells Fargo study found that, “Among those with a written financial plan, 74% of non-retired and 86% of retired feel having a financial plan with specific financial goals or targets gives them confidence they can achieve their future goals.” This means that it is not too late to put a comprehensive financial plan in place to improve your financial future.

    Please note that if a person does not start saving in his or her 20s, or saves at a lower rate than in my example above, they will need to save more later, retire later or spend less. If that person needs to save more, he or she may need to use IRAs and taxable accounts.

    The main thing is to have a plan that includes budgeting for savings and expenses. Savings is a sacrifice, and each person needs to find a level they are comfortable with. A person should have clearly defined goals and a savings plan in place to achieve those goals. If that person does not feel comfortable putting such a plan together, it is advisable to seek the professional help of a qualified financial planner.

    Tom Mooney is a financial advisor at Veritat Advisors.

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