Experts set the bar higher on saving for retirement

Your Money

December 19, 2004|By EILEEN AMBROSE

WHY ARE Americans such poor savers?

We know that retirement will come someday, and that we should salt away for it. And it's common to hear young and mid-career workers declare that they aren't counting on Social Security to be there for them. Yet none of that seems to motivate workers to save.

Back in the early 1990s, Americans saved more than 7 percent of their disposable income each year, but ever since that's been declining. In October, the personal savings rate fell to 0.2 percent, the lowest rate since the month after the Sept. 11 attacks, according to the most recent government figures. At that rate, a family with annual income of $50,000 after taxes managed to save $1.92 a week.

Whatever the reason for it - and there are plenty of theories - one thing is clear: The math is not working in procrastinators' favor. People are living longer and will need to finance decades in retirement. Traditional pensions that guarantee a monthly retirement check are disappearing. Plans to reform Social Security to make way for baby boomers might end up reducing promised benefits for future retirees.

And new number crunching from T. Rowe Price Associates suggests that workers will have to set aside for retirement more than the often recommended 10 percent of salary each year. Possibly much more.

The Baltimore-based mutual fund company is advising workers to salt away at least 15 percent of gross pay if they want to replace half of their current annual income - adjusted for inflation - in retirement. If workers get a late start, they would have to save at a higher rate, and even then might not replace half of their current income.

"There's no doubt about the fact that we are raising the bar," said Christine Fahlund, Price's senior financial planner.

Price came up with the recommendation using a complex computer program that ran each saving rate through 100,000 economic scenarios. It also made a series of assumptions, such as workers investing in 60 percent stocks and 40 percent bonds through a tax-deferred account. During a 30-year retirement, the portfolio is switched to 40 percent stocks and 60 percent bonds. Of course, making financial projections over many decades isn't an exact science, and the figures are estimates.

But say your goal is to replace half of your income each year in retirement. Social Security, a pension or other source of funds might replace another 20 percent of income. That would give you a total of 70 percent of your pre-retirement income, a figure that's been a rule of thumb for what retirees need to live on.

Here's what the computer found if you saved 15 percent of pay each year:

If you're 40 years from retirement with no savings, you would be able to replace 61 percent of your current income in retirement. If you're 30 years from retirement and have saved one year's worth of income, you'd be on target to replace half your income. And if you had only 20 years left in the work force and three years' salary in a nest egg, you would be able to replace 47 percent of current income.

But what about late starters with no savings and 20 years to retirement? Saving 15 percent a year would only replace one-fifth of their current income in retirement. Even saving 25 percent a year would yield only about one-third of income in retirement, Price found.

"It could be they don't need more than 25 percent of replacement income. They know their parents are very wealthy or they figured out the Maryland jackpot," Fahlund said.

More likely, she said, late starters will face adjustments in retirement, such as working part-time or selling a house and moving to a smaller, less expensive residence.

Price began using computer simulations several years ago to help retirees figure how much they can withdraw from portfolios without running out of money. Recently, it began focusing on savings rates.

"We decided to back up because we found that so many people had not saved enough. And they were very disappointed in what they were going to be able to do in retirement," Fahlund said.

Saving doesn't have to be so daunting if you participate in your 401(k) and take advantage of an employer match, Fahlund said.

Just under 70 percent of workers eligible for 401(k) plans participate. Those who do set aside an average of 8.1 percent of pay, and the most popular employer match is 3 percent, according to a survey last year by Hewitt Associates. Right there, a worker is saving 11 percent of pay.

Those who already max out on 401(k)s will also be able to save more next year. The maximum annual contribution for workers goes up from $13,000 to $14,000 next year. Those 50 and older next year will be able to contribute an additional $4,000, a $1,000 increase, if their plan allows catch-up contributions.

Workers can always beef up savings, too, by squirreling away bonuses or other windfalls, Fahlund said.

But can we become a nation of savers?

"People will do nothing about this until it's too late," said Barry Bosworth, an economist with the Brookings Institution. "The saving is done by very rich people. Most people save nothing."

However, the coming debate on Social Security reform might be a catalyst to spark saving, predicted Richard DeKaser, chief economist with National City Corp. in Cleveland.

"People will increasingly become aware of the deficiencies of savings and then do something to protect themselves," he said.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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