Experts routinely wring their hands about the U.S. retirement system, which largely depends on voluntary decisions by Americans regarding how much money to save and invest to generate a lifetime paycheck. Experts fret about a range of issues: 401(k) loans, leakage from early distributions before retirement, too much investment in company stock, excessive trading, inadequate savings, and over- or under-exposure to equities.
A recent report from Vanguard shows that these concerns may be overblown, although there's still much to be concerned about. The financial firm's annual report, "How America Saves 2014," shows that many employees who are covered by a retirement plan at work aren't doing a bad job of saving and investing for retirement. It also reveals there's plenty of room for improvement.
Key findings of the report.
Contribution amounts. U.S. workers' median contribution amount last year -- considering both employer and employee contributions -- was 10.2 percent of pay. Vanguard estimates that typical participants should target a total contribution rate of 12 to 15 percent of pay, which squares with the recommendations of many retirement analysts. If these participants consistently contribute these recommended amounts for 25 years or more, they have a shot at a comfortable retirement in their mid 60s. Unfortunately, only one-third of the participants surveyed in Vanguard's report had contribution levels that met its recommendations.
So is the retirement savings glass is one-third full or two-thirds empty?
The good news is that saving 10 percent of pay for 25 years or more will allow people some measure of security in retirement, which is much better than having lower savings levels. This 10-percent-per-year savings level might fund a comfortable retirement starting at age 70, if these participants also made smart choices about waiting until that age to claim their Social Security benefits.
Investments. Forty percent of Vanguard participants are wholly invested in an automatic investing program, including target date funds, balanced funds and managed accounts. Investing in these programs results in participants making fewer investing mistakes, such as putting too much money in fixed income investments or stocks, trading too often or making basic mistakes like pulling money out of the stock market immediately after it falls.
Loans. In 2013, 18 percent of participants had an outstanding loan, with an average loan balance of $9,500. Only about 2 percent of aggregate plan assets were borrowed by participants.
While taking out loans can reduce the amount of money available for retirement, the numbers reported above won't, by themselves, ruin a person's retirement prospects. In fact, there's evidence that the presence of loans increases retirement plan participation among employees with lower annual salaries. What you have to ask yourself is this: Would you rather have no retirement savings or retirement savings with loans?
If you take a loan from your 401(k) account and later repay it in full, you haven't done much damage to your retirement savings. Yes, that money was out of the market while it was on loan, and for that reason, participants with no loans have more money saved for retirement than participants with loans. But the money still made it back to your account.
The real challenge with loans is the treatment of an outstanding loan when a participant terminates employment. Most plans require the outstanding loan to be repaid in full at termination, but many participants can't find the money to repay the loan immediately, so they take an early distribution instead, incurring income taxes and possible early payment penalties. Employers could do participants a favor by allowing terminated employees to continue repaying the loan according to schedule, even after termination of employment.
Early distributions. Participants who terminate their employment are largely preserving their assets for retirement. During 2013, about 30 percent of all participants could have taken a distribution because they had terminated employment in the current or past year. The majority of the participants -- 85 percent -- preserved their assets in retirement by either remaining in the employer's plan or rolling over their savings to an IRA or to their new employer's plan. Ninety-seven percent of all assets available for distribution were preserved, and only 3 percent of assets were taken in cash.
Retirement features. With regard to drawing down assets in retirement, 60 percent of plan sponsors allow their participants to establish installment payments, enabling a "do it yourself" form of systematic withdrawals. One-quarter of plan sponsors offer an annuity payment for at least a portion of plan assets. And finally, one-quarter of participants are covered by plans that allow them to leave their assets invested and take ad hoc withdrawals.
While these features give plan participants some tools to manage their income in retirement, employers could do more to help people generate income from their savings.
Before giving our retirement system a high-five for these results, consider that only about half of all American workers are covered by the type of retirement plans Vanguard addresses. The other half are on their own to save for retirement, and many of these people have little or no retirement savings.
So what should you make of Vanguard's findings? First, Social Security alone won't fund a comfortable retirement. You'll need to save anywhere from 12 to 15 percent of your pay -- consistently -- for 25 years or more if you want a shot at a comfortable retirement in your mid-sixties. You'll also want to keep that money invested for retirement and resist the temptation to take a loan or early distribution from it.
You should do whatever it takes to use a disciplined investing approach, which means trying to resist fear and greed. Don't pull out of the market during market downturns, and don't load up on stocks after a market run-up. Professional management with target date or balanced funds is one way for ordinary workers to achieve this discipline.
Finally, you need to learn about the various methods available to deploy your savings to generate a retirement paycheck. You'll want to learn how to make your money last, no matter how long you live or what happens in the stock market.
The bottom line is that you're the person who cares the most about your retirement security. Some employers are willing to help by sponsoring their retirement plans, but it's up to you to take advantage of these benefits.