America's Perfect Retirement Storm

The Economic Policy Institute recently completed its analysis of the state of the American retirement situation and it provides us with an interesting glimpse of the future that lies ahead for millions of Americans who think/hope that they will be able to rely on their 401(k) and IRA savings to supplement their meagre Social Security entitlements.  With the shift away from the predictable income streams of defined benefit pension plans, it is far more important that families save for retirements than it has been for generations, an issue that seems to be more that slightly problematic.

Here is a graphic that shows how aggregate retirement wealth has grown in the forms of defined contribution pension plans and IRAs as compared to defined benefit pension plans as a percentage of personal disposable income between 1989 and 2014:

On the surface, it looks like aggregate retirement wealth outside of defined benefit pension plans as a percentage of disposable income is growing at a very healthy rate, rising from 31 percent in 1989 to 106 percent in 2014.  There are, however, two important factors that this graphic does not show:

1.) retirement wealth outside of defined benefit pension plans should have increased more to keep pace with an aging population and cuts in Social Security benefits.

2.) retirement wealth outside of defined benefit pension plans is far more susceptible to economic risks since investment returns are not guaranteed, a factor that became obvious during the Great Recession. 

Let's start by looking at what has happened to the mean (i.e. the average) value of all retirement savings plans by families where the head of the family was between 32 and 61 years of age in 2013 dollars between 1989 and 2013:

While the average size of retirement savings accounts has grown over the quarter century in the study, a significant portion of this growth has been among older workers who have had longer to save for their golden years.  If you take a closer look at the data, you'll see that the average working age retirement savings account has only grown from $91,243 in 2001 to $95,776 in 2013, growth of just under 5 percent in a little more than a decade.  

Here is a look at what has happened the median (i.e. the midpoint between the highest and lowest or the 50th percentile) value of all retirement savings plans by families in 2013 dollars between 1989 and 2013:

EPI's analysis shows that nearly half of all families have no retirement savings whatsoever.  This pushes down the median value for all age groups raging from $480 for families in their mid-30s to only $17,000 for families between between the ages of 56 and 61.  In addition, you can clearly see that the balances in retirement savings accounts for most age groups are less than half of their pre-Great Recession peaks and are at levels substantially the same as they were at the turn of the new millennium. 

An analysis of Social Security benefits by Monique Morrissey at the Economic Policy Institute shows that Americans over the age of 65 in 2014 received an average of $12,232 annually, hardly enough to live on.  Obviously, retirees have no choice but to supplement their post-retirement incomes from their savings both inside and outside of their retirement savings plans like 401(k)s, defined benefit pension plans (which only 21 percent of Americans have) and, most importantly, income from employment.  This is going to be particularly crucial in the current protracted low interest rate environment where even a million dollar savings pot will only net a measly $1500 or thereabouts in annual interest income.

It is becoming increasingly apparent that retirement in the new millennium will not, in any way, resemble the retirement of the parents of the baby boom generation.  With the interaction of the following four factors...

1.) the decline in the defined benefit pension system

2.) the seeming inability of many families to save for their retirement

3.) the current environment of ultra-low returns on low-risk investments and

4.) the changes in the Social Security safety net. 

...it certainly appears that the perfect retirement storm is developing.