Americans May Experience Income Drop in Retirement

American households could face an income drop of 28% in retirement. 

Nearly four in 10 retiree households (38%) report not having sufficient income to cover their monthly expenses, according to Fidelity Investments Retirement Savings Assessment. For households that are planning for retirement, estimated income gaps could force significant sacrifices that could include cuts in discretionary expenses.

To help improve Americans’ retirement readiness, Fidelity conducted an analysis that quantifies the potential monetary benefits of five straightforward steps—such as adjusting asset allocation and annuitizing retirement assets. In the context of a comprehensive retirement plan, this analysis can help individuals better understand which steps may make the greatest impact.

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“While there is evidence that Americans are saving more for retirement, our analysis finds that they need to take additional steps to prepare for the future and take better control of their personal economy,” said Kathleen A. Murphy, president, Personal Investing, Fidelity Investments. “The study underscores the importance of early engagement in the retirement planning process and the potential impact these five actionable steps can have in helping address the retirement income gap that many Americans are facing today.” 

 

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Five Steps That Can Improve Monthly Income in Retirement  

Fidelity modeled five steps for three generations (Baby Boomers, Gen X and Gen Y) to determine the potential impact on future retirement income. The steps include a mix of strategies that can be taken whether an investor is working or in retirement:

1) Adjust Asset Allocation: Twenty-one percent of those surveyed are invested too conservatively with limited exposure to stocks, based on their current age and planned retirement date. This highlights how many investors have improperly allocated their assets and are losing the long-term earnings potential of stocks.

2) Increase Savings: Respondents indicate they saved an average of $3,500 in 2011, but most are still not fully benefiting from the tax-advantaged/deferred savings potential of their workplace or individual retirement accounts. This is especially important for younger investors, who have a longer time frame and more potential for their money to grow.

3) Adjust Retirement Date: The average planned retirement age is 65, but delaying full retirement by a couple of years or continuing to work part-time can help preserve assets so they have a better chance of lasting through retirement. This can be especially powerful for Boomers, many of whom are facing a potential drop in retirement income.

4) Annuitize Retirement Assets: Fewer than one-fifth of retirees (17%) are using an annuity to create a guaranteed lifetime income stream to cover essential expenses, but it can be an important tool to help ensure savings last through retirement, particularly if a retiree lives beyond his or her mid 80s.

5) Tap into Home Equity: Seventy-two percent of respondents own a home, and one-third of homeowners (32%) have no mortgage. Through downsizing and expense reduction, home equity could be harnessed to generate income in retirement.

 

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“Most Americans have the potential to get significantly closer to achieving their retirement goals, but they have to take action and consider implementing a mix of these five steps,” Murphy said.

To help Americans take improve their current retirement plan, Fidelity released “Don’t Take a Lifestyle Cut in Retirement,” a Viewpoints article. It outlines the five steps and the hypothetical impact of each for a Baby Boomer and for a Generation X household.

A hypothetical example profiles a Gen X household, based on that group’s survey responses. This generation reported an estimated need of $4,900 in monthly retirement income. Based on their current household salary of $74,000 and the amount currently saved for retirement, Fidelity estimates these households will have approximately $3,200 in monthly retirement income—a shortfall of $1,700. After taking all five steps, this household could completely erase its estimated retirement income shortfall.

 

Hearing Examines Tax Treatment of Retirement Plans

The House Committee on Ways and Means heard testimony about the tax-favored status of retirement accounts Tuesday.

Several organizations spoke favorably about the retirement accounts.

“Employer-sponsored retirement savings plans are an indispensable building block of our nation’s retirement system,” said Randolf H. Hardock, managing partner at Davis & Harman LLP, who testified at the hearing on behalf of the American Benefits Council.

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“Retirement plans, like those sponsored and administered by the Council’s members, successfully assist tens of millions of families in accumulating retirement savings, and will provide trillions of dollars in retirement income and a more financially secure retirement,” Hardock said.

Jack VanDerhei, research director of the Employee Benefit Research Institute (EBRI), spoke to the Committee about the concept of measuring retirement security. He cited EBRI research that found 43.3% to 44.3% of Baby Boomers and Gen Xers in 2012 are projected to have inadequate retirement income for basic retirement expenses plus uninsured health care costs, a drop of 5% to 8% from the Institute’s 2003 analysis. VanDerhei attributed the improvement to the increase in the number of employers using automatic enrollment for their 401(k) plans.

David C. John, senior research fellow for Retirement Security and Financial Institutions at The Heritage Foundation and deputy director of the Retirement Security Project (RSP), provided several suggestions to help Americans improve their retirement savings.
 
An automatic IRA is not the only path to expand retirement savings for workers, John pointed out, but called it a good start. “Employer-sponsored retirement plans, including 401(k)-type retirement savings accounts, are the best way for individuals to build retirement security,” John said.

John and Hardock both stated that automatic enrollment and automatic escalation are effective ways to boost plan participation by making it easier to save. John noted the need  to extend the benefits of automatic saving to a much wider section of the population by combining several key elements of the current system: payroll deposit saving, automatic enrollment, low-cost, diversified default investments and IRAs.

Judy A. Miller, director of retirement policy for the American Society of Pension Professionals and Actuaries (ASPPA), cited data showing workplace savings as the key to promoting retirement security. More than 70% of workers earning $30,000 to $50,000 per year will participate in a plan at work, Miller pointed out, while  fewer than 5% will save on their own through an IRA.

She used data from the Bureau of Labor Statistics showing 78% of all full-time workers with access to a workplace retirement plan, and 84% of those workers participating.

Retirement Tax Incentives  

Hardock told the Committee that retirement savings tax expenditures should not be reduced or tinkered with to pay for other initiatives, either inside or outside a tax reform process.

“Significantly, the bulk of the existing ‘tax expenditure’ for retirement plans is attributable to the deferral of tax provided to already saved retirement assets, not to future annual permitted contributions,” Hardock commented.

“Existing savings should not be taxed in order to finance more government spending, deficit reduction or to offset other tax initiatives, including lower marginal tax rates,” he added.

Combining Social Security and 401(k) Statements  

John told the Committee that people need better information to make good decisions about how much they need to save for retirement. He suggested a statement that includes 401(k) and IRA information on balances, as well as Social Security benefit levels.

“Retirement savings account providers should be encouraged to add estimates of the account owner’s future Social Security benefits using information provided by the Social Security Administration (SSA) together with the annuitized value of retirement savings balances every year on either an annual statement in the case of IRAs or on one 401(k) quarterly statement,” John said.
 

Plan Simplification 

According to John the Bush Administration proposed streamlining several types of retirement savings accounts into two accounts approximately 10 years ago: a retirement savings account (RSA) and employer retirement savings accounts (ERSA). John believes these ideas are worth revisiting with changes from the original proposal.

Calling the ERSA a good idea, he said, “The original proposal would have consolidated 401(k), thrift, 403(b), and governmental 457 plans as well as Salary Reduction Simplified Employee Pension Plans (SARSEPs) and Savings Incentive Match Plan for Employees IRA (SIMPLE IRAs) into one simple account, which could be sponsored by any employer.

“The existing structure is confusing to employees, most employers, many tax professionals, and many financial services firms that don’t specialize in the specific account in question. In addition, because each account type has specific tax incentives and restrictions, it can be difficult to consolidate differing types of accounts,” John said.

He added that a simplified plan structure should encourage more employers to offer an ERSA to employees or to upgrade their automatic IRA to an ERSA. “This would almost certainly include greater coverage by small businesses. The ERSA would expand coverage, but would not eliminate the need for an automatic IRA,” said John.

Miller disagreed, stating, “A proposal to combine all defined contribution plans into a single type of plan might look like simplification on paper, but in practice, combining 401(k), 403(b) and 457(b’s) into a single type of plan would disrupt savings for employees of state and local governments and other nonprofits.”

To read the entire testimony from the hearing, visit http://waysandmeans.house.gov/Calendar/EventSingle.aspx?EventID=289485.

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