Just 1 in 4 Saving Enough in their 401k

401k, saving enough

Most aren't saving enough in their 401k for a secure retirement.

You hope Americans with 401ks are saving enough money in their plans to be able to sustain their lifestyle in retirement. But more often than not, reports come out finding most workers with defined contribution plans are in fact not saving enough to prevent financial troubles at some point in their golden years.

And sometimes it’s even worse than you think. Looks like that’s the case with new research from the Kellogg School of Management at Northwestern University in Evanston, Ill.

A new study by Enrichetta Ravina, visiting associate professor of finance at Kellogg, and coauthors Francisco Gomes of the London Business School and Kenton Hoyem and Wei Hu, both of Edelman Financial Engines, set out to determine whether Americans are saving enough to maintain their standard of living later in life.

Short answer: Nope. Nearly three-fourths of American workers with DC plans like 401ks are not saving enough, based on their current account balances, income, saving and investment behavior.

According to an April 1 post on KelloggInsight, the scope of the shortfall was even greater than Ravina expected—and it is also more dramatic than what other studies have found. The implications of the savings gap could be major. At an individual level, financial instability in retirement could mean being unable to pay for medical bills or to leave an inheritence to relatives. But at a societal level, having such a large proportion of retirees in this position is also very worrisome, Ravina says.

“This is going to be a problem for the country in general,” she says, noting that demands on federal entitlement programs like Social Security could intensify dramatically—a troubling prediction, given that those benefits are set to be fully tapped by 2034. “We will need to find ways to offer a minimum sustaining level of income to these retirees.”

Given the magnitude of the problem, the authors say in the abstract of their paper that only major policy changes would fully address it, but a reasonable age-dependent minimum contribution rate could have a sizable impact, particularly for younger generations which have many years ahead of them to benefit from such a policy.

The paper analyzed data on more than 300,000 U.S. workers at 296 different firms enrolled in DC plans to evaluate whether, given their actual savings and investment decisions, they are likely to have enough wealth to finance an optimal retirement consumption path.

The median individual has more than 40% probability of having to decrease her consumption after age 65, the paper says. Even those in the top 25th percentile of the distribution face approximately a 25% probability of having to scale down their consumption at retirement.

Among the findings:

In the absence of policy changes, Ravina says in the KelloggInsight post individuals enrolled in defined contribution plans can shore up their retirement savings by adhering to best practices: take full advantage of any contribution matching plan, start saving for retirement as soon as you start working, and avoid withdrawing money from retirement accounts if possible.

Perhaps most importantly, Ravina says, the results reveal a need for better financial literacy. She believes that too many workers postpone decisions about retirement savings and investment out of confusion and intimidation.

“It’s pretty scary; this is a system where people are increasingly on their own,” Ravina says. “This is something they need to know about.”

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