Ready or Not A new study claims baby boomers may be better prepared for retirement than we think. But let's not celebrate too soon
(MONEY Magazine) – Finally! After years of enduring an unending litany of downbeat reports on baby boomers' prospects for retirement and suffering countless lectures from finger-wagging pundits talking 'bout my generation's total cluelessness about saving for our golden years, I've come across what appears to be actual positive news. That's right--unlikely though it may seem, there's hard evidence that the 76 million spendthrift grasshoppers known as the baby boomers could actually be heading for a more comfortable retirement than we've been led to believe.
The cause for my newfound optimism is a recently released study conducted for AARP by the Urban Institute titled "How Will Boomers Fare at Retirement?" The main thrust of this research: By the time they hit age 67, the boomers will have amassed more wealth and have higher retirement incomes--even after adjusting for inflation--than their parents' generation had at the same age.
Granted, when it comes to the percentage of pre-retirement income the boomers will be able to replace as retirees--a measure of how well they'll be able to maintain their lifestyle--the results are more mixed. Early boomers (those born from 1946 through 1955) are expected to have a median replacement rate of 88%, a smidgen more than the 87% for current retirees; for late boomers (born from 1956 through 1965), that projection drops to 80%. Still, even the late boomers fall within the 70%-to-80% range of replacement income that financial planners generally recommend as a target.
As relieved as I was to hear this decidedly more upbeat assessment, I must admit I still had my doubts. After all, two annual reports released just months ago--the Merrill Lynch Retirement Preparedness Survey and the 2004 Retirement Confidence Survey by the Employee Benefit Research Institute and the American Savings Education Council--painted far more somber portraits of Americans' retirement readiness. The Merrill Lynch survey, for example, noted that while 78% of the people it canvassed are confident of their ability to plan for retirement and 51% believe they will have saved enough, the median balance of their retirement savings accounts was just $51,000--hardly enough for living large in retirement. I began to wonder whether that encouraging Urban Institute study doesn't contain some catch.
And of course it does. Not that the study is inaccurate or rigged in any way. In fact, it's quite comprehensive, in that the researchers start with data on the wealth of about 100,000 individuals--everything from pensions to homes--and then project the value of those assets plus ongoing savings to forecast boomers' resources on the eve of retirement. But with any projection looking a decade or more ahead and dealing with a large group, you've got to take a close look at the results to appreciate their limitations.
The first thing to understand is that while this study presents a relatively optimistic picture for boomers overall, there's a lot of variation around the study's medians and averages. The median retirement incomes of African-American and Hispanic boomers, for example, are projected to be as much as 30% lower than those of white boomers, while college grads' projected median incomes exceeded high school grads' by more than 40%. In other words, the retirement outlook for some baby boomers isn't nearly as rosy as it is for others.
It's also important to realize that this study provides a snapshot of boomers' financial wherewithal at a single point in time: at age 67. There's nothing to say that replacement rates won't go down as boomers age and, in fact, there's good reason to suspect that they might. The reason is that the age-67 replacement rates include a significant amount of earned income, generally from a spouse or a part-time job. While a variety of polls indicate that boomers do want to work at least part time in retirement--in a separate AARP study released this spring, 79% of boomers said they plan to work--the question remains whether they'll really do so and whether they'll be able to continue as they age and their health deteriorates. Delete those potential earnings, and the replacement rates for both early and late boomers drop considerably--to 68% and 63%, respectively--putting both groups below current retirees' 71% replacement rate excluding earned income.
There are other complications as well. The study assumes that the boomers will convert their financial wealth at age 67 into a lifetime income that will keep pace with inflation. But what if boomers splurge on second homes or lavish vacations early in retirement? Or what if they invest their retirement assets poorly or the markets turn against them? Such factors could lead to lower replacement rates and thus to a drop in the boomers' standard of living later in retirement.
Finally, even if the projections are right on, they're not a guarantee of a cushy retirement. For example, the Urban Institute researchers note that health-care costs could eat up an increasing amount of retirement income, leaving less for other expenses. Indeed, with employers cutting back on or entirely eliminating retiree health benefits, medical costs could be the wild card that wreaks havoc with the retirement dreams of even the most diligent savers and planners.
What it means to you
Okay, so maybe the Urban Institute study isn't quite as uplifting as it first seemed. But we can still apply the results from that study, as well as the more negative ones, to improve our individual retirement prospects. I see three key lessons.
1. DON'T WING IT. The only sure way to know if you're on course is to crunch the numbers--that is, set a retirement income goal and then figure out, based on what you've saved already, how much you must invest from this point on to reach your goal. Without going through such an exercise--which fewer than half of the people were actually doing, according to the 2004 Retirement Confidence Survey--you can't gauge whether you're making progress or backsliding. So if you haven't tried to calculate how much you need to save to live comfortably in retirement, do it now--and check your progress periodically. Many 401(k) plans offer retirement planning calculators and advice as part of their services. If your plan doesn't, or if you're not a participant in an employer savings plan, you can sign up for online services, such as those offered by Financial Engines (financialengines.com) and the Morningstar Online Advice program (morningstar.com). If you're wary of going it alone, consult a financial planner.
2. BE REALISTIC. One thing that jumped out at me from the predictably pessimistic Merrill Lynch survey was that, overall, people expected an average annual return of 22% from their investments in retirement. Granted, that average was inflated by some people whose expectations border on the delusional. (A quarter of the respondents foresaw investment gains of greater than 25% annually.) But even the median expected return of 10% strikes me as high, assuming that you hold a diversified portfolio of stocks and bonds. Retirement planning is one of those exercises where it pays to be on the conservative side--say, 6% to 8%.
3. TAKE RESPONSIBILITY FOR YOUR FUTURE. More than half of those polled in the 2004 Retirement Confidence Survey felt that the government or employers should pick up more of the burden of providing retirement security for individuals. But given the problems that Social Security and Medicare face and the pressure on corporations to generate profits in the competitive global business arena, expecting government and employers to do more seems like wishful thinking.
For better or worse, the onus of creating a secure retirement increasingly falls squarely on our own shoulders. The sooner we accept that challenge and begin saving and investing to meet it, the better the chance that the news will be positive when we're ready to call it a career.