How screwed are you when it’s time to retire?

Golden years.
Golden years.
Image: AP Photo/Martin Meissner
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First, the good news: You probably aren’t any worse off, financially, than previous generations who managed to retire with dignity. But even if you have decent savings, odds are you still aren’t properly prepared to support yourself in retirement. That’s the bad news.

In the past 40 years, retirement systems in developed countries have gone through a major transition, from defined benefit pensions where employers saved and invested on behalf of employees (and bore all the risks involved), to defined contribution plans where employees get money in their own accounts have to manage investments (and risk) on their own. Employers started ditching traditional pensions in the late 1970s after legislation passed that required them to fund pensions and fully account for the risks they bore in managing them. It proved easier to pass this risk onto employees.

This doesn’t mean that the current system is bad for workers—it’s just different. Some people are better off than they would be in a defined benefit world, while others are worse off. Rather than pine for the past and assume the sky is falling, many people could use a better sense of the retirement landscape.

The old system wasn’t so great

It’s tempting to idealize the past, whether it’s lost manufacturing jobs or supposed norms of civility, but the past is rarely as good as you remember. Defined benefit plans only covered, at their peak, 45% of workers in the US. Today, more than 60% of workers have some form of workplace retirement plan.

Defined benefit plans assume market and longevity risk, so beneficiaries are paid some fraction of their salary as long as they live, no matter how long that is or what happens to markets in the meantime. But employees had to deal with other risks. If they changed jobs before their pension vested, it was worthless. In a more dynamic economy, being tied to an employer poses risks for a worker’s salary and skills progression. Furthermore, if an employer goes bankrupt, pensions are taken over by regulators and are often slashed.

You have more than you realize

We often see scare stories from media outlets warning about how few people have saved enough for retirement. Indeed, there are many people that go into retirement without savings. Some because they did not make enough money to save, others should have saved but didn’t, and others were unlucky with their investments. According to the Federal Reserve, in 2016 about 28% of 60-to-65 year olds in the US had less than $25,000 in financial assets; 36% had that or less in 1989 (adjusted for inflation).

Many people have decent savings when they account for all their sources of income. The American Enterprise Institute’s Andrew Biggs argues that low-income Americans don’t have much retirement savings, but they get a large benefit relative to their working incomes from Social Security. And Americans who work for the government still get a defined benefit pension.

When it comes to middle-class savers, even without a defined benefit plan, the picture isn’t so bad. Estimates from the Fed suggest that average financial savings among middle earners between age 60 and 65 are about $240,000. That’s not enough for a plush retirement, but it translates to about $13,500 a year in income which, along with about $30,000 in Social Security, is well above the poverty line. And it is more than people used to have. The average middle-earning household of the same age had only saved around $180,000 (in 2016 dollars) back in 1989.

The average earner might be in decent shape, or at least a little better off than previous generations, when it comes to saving. An important caveat, though, is that people are retiring with more debt than before.

Retirement isn’t risk free

Although things may not be as bad as they seem, there is scope for improvement. A problem bigger than under-saving is that retirement policy has never addressed the consequences of forcing households to bear so much risk.

Saving enough, managing investment risk, and knowing how much you can spend in retirement is hard. The retirement industry has cracked the saving problem, making it more common to automatically sign people up for plans, which boosts savings, and put money in low-cost, well diversified index funds, which reduces some risk and eliminates excessive fees.

But there’s still the risk of outliving your money or under-spending it and living out a needlessly thrifty retirement. Many retirees don’t have a good sense of their expenses, how to invest their savings after retirement, or how much they afford to spend. Evidence suggests that even though people go into retirement with savings, they don’t spend much of it. It’s no wonder, since you don’t know how long you will live, what your health expenses will be, and what will happen to markets.

There are some potential solutions in the works for those problems. States are offering retirement accounts and proposed legislation in Congress would make it cheaper for small plans to offer 401(k)s, which will increase saving. The legislation would also encourage 401(k)s to offer an annuity option, which transfers longevity and market risk to an insurance company. Americans need more education and advice on whether an annuity is right them, what they can expect from social security, what sort of lifestyle pensions can realistically support, and how to manage the risk of over- or under-spending.

If there is a widespread retirement crisis, it is a crisis of information, not under-saving. And that can be just as bad.