Behavior
October 23, 2012
401(k)s “Top” Financial Priority. Really.
A large majority of people in a survey released last week identified saving for retirement as their top financial priority. If that’s the case, then why aren’t Americans saving enough?
Stuart Ritter, senior financial planner for T. Rowe Price, the mutual fund company that conducted the survey, has some theories about that. Squared Away is also interested in what readers have to say and encourages comments in the space provided at the end of this article.
But first the survey: about 72 percent of Americans identified saving for retirement as “their top financial goal,” with 42 percent saying that a contribution of at least 15 percent of their pay is “ideal.”
Yet 68 percent said they are saving 10 percent or less, which Ritter called “not very much.” The average contribution is about 8 percent of pay, according to Fidelity Investments, which tracks client contributions to the 401(k)s it manages.
The Internal Revenue Service last week increased the limit on contributions to 401(k) and 403(b) retirement plans from $17,000 to $17,500. The so-called “catch-up” contribution available to people who are age 50 or over remains unchanged at $5,500.
The question is: why do Americans give short shrift to their 401(k)s, even as people become increasingly aware that their dependence on them for retirement income grows? Ritter offered a few theories in a telephone interview last week:
- The financial industry is partially to blame. “We have done a really good job of conveying to people how important saving for retirement is,” he said, “but what we haven’t done as good a job of is telling them how much to save.”
Employers may also share blame. Further confusing the issue, the savings rate depends on when the employee starts saving – the percent of pay is lower for those who start in their 20s than for someone who waits until they’re 45.
- People are simply too busy to deal with what is a complex – even vexing – issue. “As human beings,” Ritter said, “we have a whole list of things we want to do but haven’t gotten to it yet.”
- He also cited behavioral economics research, which has shown that employers unfortunately send the message to their workers that, say, 3 percent is sufficient, because that’s the contribution required to be eligible for the employer’s match contribution.
There’s another obvious reason Americans are not prepared for retirement. The Great Recession and unemployment have put an enormous dent in the ability of Americans to save, and they’re still struggling to catch up, according to forthcoming research by Karen Smith at the Urban Institute, a non-profit research organization. “The drop in real wages has the biggest effect” on retirement savings and income,” Smith said in the video shown here. “When wages fall, we earn less, we save less, and we lose the investment returns on those lost savings.”
But what about psychological reasons, such as denial? I labeled another psychological state The Big Freeze in a 2011 article: people don’t know what to do, so they do nothing. For others, saving for retirement is a lot like dieting – downright unpleasant.
Whatever the reasons, evidence is overwhelming that Americans are ill-prepared for retirement: In 2010, the typical U.S. baby boomer households had $42,000 in their retirement plans at work, a few bucks lower than their 2004 balances, according to the Center for Retirement Research. More than half of all Americans are “at risk” of having a lower standard of living once they retire, up from 43 percent in 2009, the Center estimates.
[Full disclosure: the Center funds this blog, and T. Rowe Price is a corporate partner of the Center.]
Retirement savings is not easy to think about, much less act on. But hopefully readers will weigh in!
Just as people say one thing in polls and then another when they go to the vote, I suspect that this is the case here. They say that retirement is important because that’s what they think they should say (or, alternatively, know that’s what they should say). However, humans discount the future utility of actions versus the current utility. It’s much easier to commit yourself to go to the gym tomorrow than it is to actually go to the gym today.
Another reason that people don’t save enough is that they think that they can outperform the market sometime down the road and make up for lost time through superior performance. Given that it’s a low interest rate environment, they tell themselves that they’ll wait until interest rates are higher, disregarding that the stock market has already rebounded.
This isn’t an issue of education as much as it is about overcoming behavioral issues and limiting beliefs. Psychologically, we go to defaults, so if someone is a paternalistic libertarian, he’d encourage a higher 401(k) match to more closely approximate how much people should be saving.
Article needs a correction: Last week the IRS increased 2013 max contributions to $17,500. The link and your comment are referencing a 2011 announcement on 2012 max limits.
Dear Skip,
Thank you for pointing out the inaccuracy. We have corrected the text to show 2013 contribution limits.
Kim, Squared Away writer
The financial industry doesn’t sell financial products, it sells magical solutions. “You don’t have to save very much at all, because when you give us your money, you will get these wonderful returns in the stock market!!!” If people were told the truth about how much you need to save (e.g., Zvi Bodie’s advice), they might instead buy a lot of boring products (e.g., TIPS) that don’t make the brokerages a lot of money, but they might finally save enough to retire comfortably.
When employees are asked what their first priority is for benefits, retirement always finishes a distant second to healthcare. It’s what I need now versus what I need later.
The reason people don’t save more is that, outside of the top tax bracket, everybody else has flat wages and increasing contributions toward healthcare.
It’s hard to save more in a 401(k) when the cost of your health plan goes up 10% every year.
Being the broker for two 401(k)s, the missing component is simple: people cannot save money for the most part nor do they wish to become savers. I have only met a few who are real, true savers. The rest are stop and start savers, the minute a crisis hits they drain the account. I am not sure when buying a big screen TV was considered a crisis, but it is. The attitude is very simple: I work to spend. There is nothing the government can do to change that unless we start at a very early age and make saving a good thing and a goal for life. Even when you are broke you can still save. Believe me, I’ve been there, done that and it works, but only for me.
I think it’s a combination of factors. Some people are simply spenders, not savers. Others try to do their best, but the fact is that real wages in this country have been stagnant for some time now. Throw in rising health care costs, skyrocketing tuitions, $4/gallon gasoline, and there simply is little left over for many people. The top executives are doing just fine, especially when you throw in their equity compensation. But for the rank and file, simply making ends meet is always going to be a higher priority than a retirement that is decades away.
Great post on the importance of making saving for retirement a top priority. Understanding how much savings is needed is a very important step in this process. At the end of the day, it isn’t always easy for an individual to look at a balance and determine if that is going to meet their needs in retirement. The perception of what is enough can often vary.