One of the toughest challenges Americans face in life is saving up enough money for retirement. On paper, retirement planning looks as simple as one, two, three, but when curveballs are thrown in, which can include unexpected medical costs, costs associated with starting a family, paying for college, buying a home, or buying a car, that very simple plan often gets completely thrown out the window. Ultimately, some people are well-prepared for retirement, while others are struggling to get on track.
According to the Pay Yourself in Retirement study released by Ameriprise Financial this week, which surveyed more than 1,300 baby boomers between the ages of 55 and 75 with at least $100,000 in investable assets, there are marked differences in both the financial habits and outlooks between current retirees and pre-retirees -- people who are typically a decade or less away from retirement.
Retirees' and pre-retirees' different paths to the finish line
Ameriprise Financial's study had one goal: to understand how pre-retirees were planning to pay for their lifestyles once they gave up their paychecks, and how retirees were doing it. What Ameriprise discovered was that aside from a few similar concerns -- healthcare expenses and fear of market volatility -- the two sides were actually quite a distance apart in terms of retirement preparedness.
Some of the key findings about retirees:
- 85% have a plan in place to pay themselves in retirement;
- 65% have identified the assets they plan to drawn upon first in retirement;
- 71% plan to rely on pensions as their top source of income during retirement;
- 41% are making investments with the explicit purpose of generating additional income.
Now, let's compare this to some of the findings about pre-retirees:
- 52% have a plan for generating income in retirement; yet ...
- 53% haven't thought about their top source of income in retirement as of yet;
- 38% have decided what assets to drawn upon first in retirement;
- 46% of their cumulative income will come from 401(k)s and Social Security.
It's worth noting that this study only chose to include boomers who had $100,000 or more in investable assets. As we learned from the 2014 Survey of Household Economics and Decisionmaking, a ridiculous 31% of non-retirees (of any age) had no savings or pensions whatsoever. Thus, the figures above are being buoyed by the fact that Ameriprise is focusing on a group of individuals who are well ahead of a large chunk of Americans in the saving department.
Three sizable differences
Nonetheless, some remarkable differences emerge in the above data.
For example, the primary source of income during retirement has shifted pretty substantially over the past couple of decades. Pensions, which are funded and managed by employers, have given way to the 401(k), which requires the employee to take an active role in saving and investing for their retirement. If pre-retirees aren't taking that active role, or are missing out on possible company 401(k) matches, they could be doing themselves a major disservice.
Secondly, most retirees have a plan in place to access their money come retirement. Why's this important, you wonder? Not having a budget in place prior to retirement could mean drawing down on your nest egg at too rapid a pace and outliving your money. In fact, 55% of pre-retirees expressed concern about burning through their assets too quickly during retirement. Additionally, not having a plan in place can lead to retirees to make decisions without understanding that tax implications, resulting in higher tax bills that might have been avoided with more forethought.
Lastly, even though I've not included it in the above data comparisons, there's a minor difference in reliance on Social Security now that could turn into a bigger issue during retirement for today's pre-retirees. Based on the survey results, current retirees plan to get 23% of their income from Social Security, while pre-retirees expect to get 25%. That may not sound like a huge difference, but the Social Security program is on an unsustainable slope. It has been paying out more in benefits than it receives in tax revenue for some years, and will keep doing so in the years ahead. Unless Congress acts, by 2035, the program's cash reserves will be gone, and a benefits cut of up to 21% may be needed to sustain the program through 2087. The threat of a cut won't dramatically affect current retirees, but it's just one more risk for those pre-retirees who plan to lean on Social Security in retirement.
Idea. Plan. Action!
We've seen the differences. Now let's look at a few ideas and plans of action to close this gap in financial preparation.
One of the smartest ways pre-retirees can focus on preserving their investable cash in retirement is by really hammering out a plan to reduce the amount they pay in taxes. There are a couple of ways of accomplishing this.
First, a tax-advantaged retirement plan helps. A 401(k) is a good example of a tax-deferred plan that provides an immediate tax-liability-lowering boost while allowing you to invest for your future. However, a Roth IRA, should you qualify (there are income limitations), allows your money to grow completely free of taxation for the life of the account, as long as you make no unauthorized withdrawals. A Roth could save you a lot of money over the course of your lifetime.
Also consider that where you retire can make a big difference. Some 13 states tax Social Security benefits to varying degrees, while all states offer some mix of retirement, property, and state or local taxes. Understanding the dynamics of what you might owe based on where you retire can help save you money.
Budgeting for your future can also go hand-in-hand with minimizing your tax liability. Having a concrete budget in place before retirement can ease your transition into a potentially lower-income bracket -- it's common to receive less income on a monthly basis during retirement than you did when you were working. It also can ensure you don't burn through your nest egg too quickly, or withdraw so much money in a given year that you move into a higher marginal tax bracket.
Beyond taxes, it's important that pre-retirees take the time to become involved in their own financial planning. Whether they choose to hand most of the heavy lifting over to an advisor, only consult with an advisor, or handle their own finances, it's important that they have a basic understanding of their financial plan and what they'll need to do to achieve it. If you're wondering where to start, The Motley Fool's retirement center is a good jumping-off point.
Retiring in style isn't out of reach -- it just takes some planning and dedication. Make today the day that your retirement gets back on track.