Your 401(k) is up, but a new report says Americans need to save more

What does your 401(k) look like? A new report shows that Americans are saving more, but probably need to do more.

Vanguard has released its annual report, How America Saves 2024.Vanguard and Fidelity are the two largest sponsors of 401(k) plans, and this is a snapshot of what nearly five million participants are doing with their money.

The good news: Stock market returns have risen and, thanks in large part to automatic enrollment plans, investors are saving more than in the past.

The bad news: Account balances for the average 401(k) of a person nearing retirement (65+) remain very low.

The takeaway: Americans are still heavily dependent on Social Security for much of their retirement

Higher returns, participation rates, savings ratesa

Why do we care so much about 401(k) plans? Because it is the most important private savings tool Americans have for retirement. More than 100 million Americans are covered by these defined contribution plans, with more than $10 trillion in assets.

Firstly, 2023 was a good year for investing. The average total return for participants was 18.1%, the best year since 2019.

But to be effective retirement tools, these plans must: 1) have high participation rates, and 2) have high savings levels.

There is good news on those fronts. John James, director of Vanguard’s Institutional Investor Group, called it “a year of progress”

Participation in the plan reached a record high Thanks to a change in the law several years ago, an all-time high of 59% of plans offered automatic enrollment in 401(k) plans. This is a big improvement: previously, there was often a shortage of enrollment in 401(k) plans. expectations because investors had to ‘opt-in’, that is, they had to choose to participate in the plan. Due to indecision or simple ignorance, many did not. By switching to auto-enrollment, participants were automatically enrolled and had to “opt out” if they did not wish to participate

The result: enrollment rates have increased. Plans with automatic enrollment had a 94% participation rate, compared to 67% for voluntary enrollment plans.

The savings rate of participants reached a record high The average participant deferred 7.4% of their savings. Including employee and employer contributions, the average total participant contribution was 11.7%

A few other notes about Vanguard’s 401(k) plan investors:

They prefer stocks and target date funds They like stocks more than bonds or other investments. The average plan contribution to shares is 74%. A record high of 64% of all contributions in 2023 went to target-date funds, which automatically adjust stock and bond allocations as participant ages

They don’t trade much.In 2023, only 5% of unadvised participants traded through their account; 95% didn’t trade at all. “Over the past fifteen years, we have seen an overall decline in participant trading,” Vanguard said, which is partly attributed to the increased adoption of target-date funds.

Despite market gains, account balances are still low

In 2023, the average account balance for Vanguard participants was $134,128, but the average balance (half had more, half had less) was only $35,286.

Why such a big difference between the mean and the median? Because a small group of investors with large balances pull the averages up. Forty percent of participants had less than $20,000 in their retirement accounts

Distribution of account balances

• Less than $20,000 – 40%
• $20,000-$99,999 30%
• $100,000-$249,900 15%
• $250,000 + 15%

Source: Vanguarda

Average balances for people nearing retirement are still low

Another way to look at the problem is to ask how much people have saved at retirement age, as this is an indication of how prepared they are for impending retirement.

Investors age 65 or older had an average account balance of $272,588, but an average balance of only $88,488.

A median balance of €88,488 is not much when you consider that older participants have higher incomes and higher savings rates. That’s not a lot of money for a 65-year-old nearing retirement.

Of course, these balances don’t necessarily reflect total lifetime savings. Some have more than one pension plan because they had different plans with previous employers. Most have other sources of retirement savings, usually Social Security. An increasingly smaller number of people may also have a pension. Some may have money in checking accounts, or own stocks or bonds outside of a retirement account

Either way, the math doesn’t look great

So let’s do some retirement math

A typical annual withdrawal for a 401(k) account in retirement is about 4%. By subtracting 4% from €88,488 per year, you get €3,539 per 12 months.

Then social security. From January 2023 the average Social Security benefit was almost $1,689 per month, or about $20,268 per year.

Finally, even though pensions are a disappearing benefit, let’s include them

According to the Pension Rights Center the average annual pension benefit for a private pension is $9,262 (government employees have higher benefits).

This is our annual pension budget:

• Personal savings $3,539
• Pension $9,262
• Social Security $20,264
• Total: $33,065

It’s certainly possible to live on $33,000 a year, but this probably only works if you own your home, have low expenses, and live in a cheap part of the country.

Even then, it would hardly be a robust pension

And these are the lucky ones Only 57% of retirees have a deferred retirement account such as a 401(k) or IRA. Only 56% reported receiving income from a pension

And that extra income largely determines whether a retiree feels good or bad about his pension

In 2023, four in five retirees said they were doing at least well financially, but this varied greatly depending on whether retirees had sources of income outside of Social Security. Only 52% of retirees who had no private income said they were doing well or at least okay financially

What can be done?a

To have a more robust retirement, Americans will simply have to save more

One problem is that investors are still not contributing the maximum amount allowed. Only 14% of participants saved the legal maximum amount of $22,500 per year ($30,000 for people aged 50 or older). The likely reason: Most felt they couldn’t. afford to.Â

But even those with incomes above $150,000 contributed only 53% of the maximum amount allowed. Given that the employee match is “free money,” you would think that participants in that income bracket would rationally choose to maximize their contributions. The fact that Many still don’t suggest that more investor education is needed

Either way, it is very dangerous to assume that retirees will be saved by an ever-rising stock market. Another year somewhere around 2022, when the S&P 500 will fall 20%, and investors’ confidence in their financial future will likely deteriorate.