What about your 401(k)? A new report suggests that Americans are saving more, but they probably need to save even more.
Vanguard released its annual report. How America can save 2024. Vanguard and Fidelity are the two largest sponsors of 401(k) plans, and this is a snapshot of how their roughly 5 million participants spend their money.
The good news is that stock market returns are rising and investors are saving more than ever before, thanks in large part to auto-enrolment.
The bad news is that the median 401(k) account balance for people nearing retirement (age 65 and older) is still very low.
Bottom line: Americans still rely heavily on Social Security for much of their retirement.
Higher returns, participation and savings rates
Why do we care so much about 401(k) plans? Because they are the primary personal savings vehicle Americans have for retirement. Over 100 million Americans are covered by these “defined contribution” plans, representing over $10 trillion in assets.
First, 2023 was a good year for investors, with participants’ average total return of 18.1%, the best year since 2019.
But to be a viable retirement vehicle, these plans require 1) high participation rates and 2) high savings.
There is some good news on this front: John James, managing director of Vanguard’s Institutional Investor Group, called this year “a year of progress.”
Participation in the scheme reached an all-time high. Due to a change in the law a few years ago, a record 59% of plans now offer automatic enrollment in 401(k) plans. This is a big improvement. Previously, participation in 401(k) plans was often disappointing because investors had to “opt in” – choose whether or not to participate in the plan. Many didn’t participate because they were indecisive or simply didn’t know. With the switch to auto-enrollment, participants were automatically enrolled and had to “opt out” if they didn’t want to participate.
As a result, enrollment rates increased: 94% of people enrolled in automatic enrollment plans, compared with 67% of people enrolled in voluntary enrollment plans.
Participants’ savings rates reached an all-time high. The average participant deferred 7.4% of their savings. Including employee and employer contributions, participants’ average total contribution rate was 11.7%.
Other observations for Vanguard 401(k) plan investors:
They prefer stocks and target date funds. They prefer stocks over bonds and other investments. The average plan contribution to stocks is 74%. A record 64% of all 2023 contributions went into target-date funds, which automatically adjust the allocation of stocks and bonds based on participants’ ages.
They don’t do much trading. Only 5% of non-advised participants traded in their own accounts, and 95% did not trade at all in 2023. “Participant trading has generally trended downward over the past 15 years,” Vanguard said, citing the increased adoption of target-date funds as one factor.
Account balances remain low despite market rally
In 2023, the average account balance of Vanguard participants was $134,128, but the median (half had more, half had less) was just $35,286.
Why is there such a big difference between the average and the median? Because a small number of investors with large balances are driving up the average: 40% of participants had less than $20,000 in their retirement accounts.
Account balance distribution
- Less than $20,000: 40%
- $20,000 – $99,999 30%
- $100,000 – $249,900 15%
- $250,000 + 15%
Source: Vanguard
Median balance for those nearing retirement remains low
Another way to look at this issue is to ask how much people of retirement age have saved, because that is an indicator of how prepared they are for their impending retirement.
Investors age 65 and older had an average account balance of $272,588, but the median was just $88,488.
Given that older participants have higher incomes and higher savings rates, the median balance of $88,488 isn’t a huge amount — not a lot of money for a 65-year-old approaching retirement.
Of course, these balances don’t necessarily reflect your total lifetime savings. Some people have more than one retirement plan because they had other plans with previous employers. Most people have other sources of retirement savings, such as Social Security. Many have pensions. Some people also have money in checking accounts or stocks and bonds in addition to their retirement accounts.
Either way, the math doesn’t look good.
Now let’s do the maths on retirement.
Typical annual withdrawals from a 401(k) account in retirement are about 4%: Withdrawing 4% of $88,488 per year would give you $3,539 every 12 months.
Next, regarding Social Security, as of January 2023, the average Social Security benefit was approximately $1,689 per month, or approximately $20,268 per year.
Finally, include pensions, even though they are a disappearing benefit.
According to the Pension Rights Center, the average annual pension benefit for a private pension is $9,262 (government employees get higher benefits).
Here is our annual retirement budget:
- Personal savings $3,539
- Pension: $9,262
- Social Security $20,264
- Total: $33,065
While it is certainly possible to live on $33,000 a year, this is probably only achievable if you own your home, have low expenses, and live in a less expensive part of the country.
Still, it wouldn’t be a satisfying retirement.
And these are the lucky ones: Only 57% of retirees have a tax-deferred retirement account like a 401(k) or IRA, and only 56% report receiving income from a pension.
And that extra income can make a big difference in whether a retiree will be satisfied or dissatisfied with their retirement life.
By 2023, four in five retirees said they would be at least financially comfortable, but this varied widely depending on whether the retiree had an income source other than Social Security. Only 52% of retirees with no personal income said they would be at least financially comfortable.
What can you do?
To enjoy a better retirement, Americans need to save more.
One problem is that investors are still not contributing the maximum allowed: Only 14% of participants saved the legal maximum of $22,500 a year ($30,000 for those over 50), likely because most people felt they could not afford to save.
However, even among those earning more than $150,000, only 53% contribute the maximum. Given that employee contributions are “free money,” participants in this income bracket would rationally choose to max out their contributions. Yet the fact that so many people do not max out their contributions suggests that more investor education is needed.
Either way, it’s very dangerous to think that retirees will be bailed out by an ever-rising stock market. If the S&P 500 falls 20% around 2022, investors will likely have less confidence in their financial future.