401K Math

[WestSeattle2]

Recently there has been a lot of news in the Seattle area involving Boeing Machinists and the Boeing Company's attempt to end their current defined pension plan. Many don't understand why Machinists are fighting this attempt so rigorously. Over the years I've shown many family and friends that 401K math just doesn't work at the macro level and that defined pensions of some kind are needed. Let's take a look at the math.

Most Americans would consider $60,000 income per year in retirement to be adequate. Yes, in many areas of the country, particularly the interior, one could retire nicely on half that amount, or even less. However there are many locations on the coasts where $60,000 would hardly be considered adequate. But for the sake of argument, let's assume that most American's could survive on $60,000 per year. That's not a life of luxury, but it would cover housing, insurance, food, medicine, and some entertainment.

Financial planners agree that withdrawing 4% of investment income per year, should ensure that your investment money will carry you to the end of life. Withdrawing more may put you in the position of outliving your money; which many would consider a bad thing. So let's stick with 4% withdrawal rate.

In order to generate $60,000 per year in income then, you need $1,500,000 in a 401K. That's in today's dollars. How many of your friends and neighbors do you suppose have $1.5M in a retirement fund? Next, those who are 25 years old today, will need to generate approximately $200,000 per year in retirement income when they retire in 2053, to match what $60,000 buys today (assuming a 3% inflation factor for 40 years.) How much will they need in their 401K to generate that income? Using the 4% withdrawal factor, they'll need $5M. How much do they need to be saving each month to reach that $5M goal in 40 years? $3,300 per month, and that's assuming a 5% rate of return every year for the next 40 years.

How many 25 year old workers do you believe are saving $3,300 per month? At the same time they're expected to pay off student loans, raise a family, educate their children, care for elderly relatives, and pay off a house before they retire, at the same time wages have stagnated or have fallen? None of my nephews or nieces in that age group are doing that. Some are barely EARNING that.

According to the 2010 Census, there are approximately 200M citizens under the age of 44; most of whom need to be saving $3,300 per month in order to have a decent retirement. What percentage of those will be successful? I submit that perhaps 20% might make the goal - and that's being generous. What happens then to the remaining 80% who fall short? We're talking about 160 million Americans who will either not retire at all, or will retire on subsistence level incomes. Meanwhile corporate profits are through the roof; corporate taxes are laughably low; and executive salaries have exploded.

And this in the richest country in the world. Welcome to the world of 401K's.

I'm headed out now so won't be available to respond to comments, but I'll respond as soon as I'm able.

[PowerToThePeople]

1. I have been saying something similar for years.

In order to retire with pre-retirement income levels, I would need to save more than 100% of my take home pay for the remainder of my working years. I have accepted that I will live a very meager post retirement life.

edit - better learn to find happiness in things that do not cost dollars, because there will be no dollars available for you.

[Le Taz Hot]

2. I've never done the math as you've done

but the first time I heard about 401K's (70's?, 80's?) and how they were just THE THING for retirement purposes the first thing I thought of was, "But they're not protected. There's nothing keeping the company/corporation/entity from raiding that money." Used to be that pensions were a safe retirement but even that's being threatened now.

[Warren Stupidity]

7. Raiding isn't the problem, pushing all the risk onto individuals is.

Corporations and government are notorious for raiding traditional pension programs, but aside from shitty practices like limited high expense investment options, 401ks are pretty much immune from raiding.

[Paulie]

3. You can't save 3k a month into a 401k

Cap is around 16k/yr for a 401k (plus 5k additional for catchup if over. 50)

One thing you can do to control it is work for a company which has a company match for contributions and/or profit sharing. That way you can put in up to the cap and the employer additions don't count towards your annual cap.

Then you also have to some how save the difference for that 3k a month.

It's a bit insane isn't it?

[WestSeattle2]

11. Correct; you have to split your retirement savings. The max contribution for a 401K is far less

than $3,300 per month. Multiple investment vehicles (like adding a Roth) are required.

It is absurd to think that average folks can work 40 years and save enough for a 25 or 30 year retirement. And even if they were able to - our economy would collapse. 70% of our national economy is based on consumption. If people saved instead of spent, that would shoot a hole in the economy.

[FreeJoe]

20. $52,000

$52,000 is the max you can contribute to a 401k in 2014. Only $17,500 of that can be tax deferred income contributions. the remainder could be matching payments or after tax contributions. you can also set aside another $5,500 in an IRA.

[Egalitarian Thug]

4. It was always a scam. It was invented as a vehicle for high salaried executives

to circumvent regulations and taxes. Flogging it onto the little people as a replacement for pensions that politicians didn't want to regulate anyway was evil.

Convincing muffler shop managers that they didn't need an "old fashioned", risky retirement plan because they would retire millionaires after putting their money into a rigged game, that was inspired.

[gulliver]

5. I like Social Security

I would only consider a defined pension if it were backed by the federal government. If you have a pension with a company, the company can go under. In fact, your pension can be a reason to let the company go under. Then let's just say the word "Illinois" and leave a discussion of state-guaranteed pensions at that.

401(k)s and SEPs are the next best thing to Social Security, imo, but they create and suffer from bubbles. That's why I have to laugh when I hear someone who buys into the Republican FUD about Social Security.

[hfojvt]

6. gotta stop you right from the start

a $60,000 pension is a pipe dream for the VAST majority of Americans.

Let's just look at Washington. According to ITEP, 60% of non-elderly households in Washington make less than $60,000. Those are people who are working, often with two incomes in the household.

Is $40,000 NOT considered an adequate income in Washington? Well, 40% of Washington households are currently living on less than $38,000. http://www.itep.org/pdf/wa.pdf

So you begin your calculations based on non-working people making far greater income than many, if not most, working people cannot make. Those are faulty calculations.

[WestSeattle2]

9. This is just hypothetical - adjust the math for your personal situation. If you broke down state

income by city, you'd probably find that incomes in Seattle, San Francisco, and Los Angeles average substantially more than statewide averages would suggest. $60k in the city of Seattle is adequate; $40k borders on subsistence. Of course this is all subjective; one person's idea of adequate may differ greatly from another's. But $40k would probably be considered adequate in most of Eastern Washington.

The underlying point of my post is that 401K math really doesn't add up on a macro level. We're beginning to see that play out with boomers; subsequent generations, especially those under 44 years old, will probably have nothing but 401K income to rely on. At least some boomers have pensions plus Social Security.

[hfojvt]

15. the Seattle metro area has over half the state's population

so I have to believe that SOME of the 60% making less than $60,000 a year are living in Seattle.

But the calculations change greatly if you go from $60,000 down to just $30,000.

Plus, the 401K is not the only factor in retirement income. You also have IRAs, Social Security and other personal savings. And the employee is not the only one who contributes to a 401K. Often the employer will match contributions. At Citibank, they contribute 3% to their lower paid employees even if the employee contributes nothing. $800 a month in social security income, knocks the needed income down from $30,000 a year to $20,000 a year.

Further, the 4% number seems kinda arbitrary and partly depends on the return on investment. If my portfolio is earning 3% on average then I can take out 5% or even 6% and still have it last a good long time. Meaning my nest egg does not need to be as big as you are claiming.

Finally, if it is so impossible for an employee to bank enough to make a defined contribution pension an impossibility, then how do you expect an employeR to be able to put enough away to cover a defined benefit pension? Which would take an even bigger pile of money since it is a bigger benefit.

[El_Johns]

18. In 2011 median household income in Seattle was $45K. The overwhelming majority of retired

households get nowhere near $60K.

[Dawgs]

8. Your math doesn't include Social Security. Are you assuming it won't be around?

Because, if you think it will be around you need to adjust your math.

You also need to realize that many of those experts are assuming people will have 30+ years of retirement, which is a joke.

Yes, 401ks are bad for most, but your math is way off unless you're only looking at extreme scenarios.

[hughee99]

10. Yes, this AND what about interest on your 401K AFTER you start taking out 4%

You still get a return on the money that you haven't taken out yet. If you take out 4% per year, and your 401K increases in value by more than that, you're only taking out that year's profits.

[WestSeattle2]

12. And conversely, you could go years with no return on investment - none. You could lose

principal on top of your 4% withdrawals. At that point you're too old to work and replace the lost principal.

[hughee99]

14. So you're willing to concede a 5% return for the 40 years someone pays in,

but not assuming ANY return after the person retires?

[Warren Stupidity]

16. Luckily you aren't providing financial consulting services.

The 4% withdrawal rate includes earning accumulation in the calculation, and losses too. The idea is to not outlive your savings. It truly sucks to be destitute in your 80s, so you have to take a risk averse conservative approach. Of course if you can't live on a 4% withdrawal rate "risk aversion" is irrelevant. Most people don't have anywhere near enough saved, which was more or less the point of the op.

[hughee99]

17. You did read the OP, right?

"In order to generate $60,000 per year in income then, you need $1,500,000 in a 401K. That's in today's dollars. How many of your friends and neighbors do you suppose have $1.5M in a retirement fund? Next, those who are 25 years old today, will need to generate approximately $200,000 per year in retirement income when they retire in 2053, to match what $60,000 buys today (assuming a 3% inflation factor for 40 years.) How much will they need in their 401K to generate that income? Using the 4% withdrawal factor, they'll need $5M. How much do they need to be saving each month to reach that $5M goal in 40 years? $3,300 per month, and that's assuming a 5% rate of return every year for the next 40 years. "

According to the "401k math" laid out in the OP, if you are 25, you'd have 40 years to retirement and need $5 million at retirement to guarantee $200k per year (for 25 years, or until the retiree reaches 90 years old). The math on this only works out if you assume NO earnings accumulation. Any earnings accumulation and you're taking out money well into your 90's and beyond. The OP did the math and no such factor is taken into account. Perhaps you should have said "Luckily the OP isn't providing financial services". This is leaving aside SS as well, as it was already mentioned.

[bhikkhu]

13. Hypothetically, its far easier than that in my case

Assuming a worst case scenario, where for some reason I have to buy another house or refinance and have mortgage payments to the end of my life, then I would need to continue making $30k per year. Assuming I were able to invest and see a return of 5%, and that inflation ran at 3% (both of which are pretty pessimistic figures), something around $1 million in the bank would suffice.

But that's assuming a relatively high inflation rate, a conservative return rate, that I never reduce my expenses by owning my house, and that the principle remains as an untouched investment.

In reality I don't in any realistic scenario have that kind of money to work with, but I will have a house paid off when I turn 62. Then I can conceivably get a reverse mortgage, and I will be soon eligible for SS payments, and living expenses will be more like $20k (in today's dollars). And I'll have some amount of savings to help. Not to argue too much, but just that all kinds of individual circumstances are variable, and people who do have 401k's (which I don't) probably also have many more options available to them.

Regardless of all that, I'd rather see the minimum wage raised so people entering the workforce can live decently than anything else.

[FreeJoe]

19. pensions are not magic

The same amount must be saved to pay a retirement income regardless of whether it is saved through a defined benefit (pension) or a defined contribution _(401k) plan. You 4% rule aims that you want to preserve principal forever For retirement, an annuity would provide for a higher income stream for the same amount of savings.

[cbdo2007]

21. I would rather put my trust in hundreds of companies than just one...

for my retirement dollars. We've seen it happen too many times, now with local governments even, is that when something happens your pension could go down with the company. Sure, there are a lot of companies that are still going to be around and successful in 30 years, but many will not be. The market averages this out for you.