Deciding how much to save for retirement is one of the most important financial decisions people make. A new study shows many don't save enough.
In a sample of more than 300,000 people with 401(k) accounts, 75% won't be able to maintain their lifestyles when they retire, according to the study. In the past, many Americans worked at companies that paid defined benefits in the form of pensions. Today, most of the responsibility for saving for retirement falls on workers.
"It's up to you to decide how much to save and how to allocate your savings," said Enrichetta Ravina, a professor of finance at Northwestern University's Kellogg School of Management and one of the authors of the study.
This responsibility creates the potential for people to make mistakes in their retirement decisions. Ravina and her coauthors wanted to study those decisions.
Many financial advisers tell people they should save enough to replace about 80% of their pay when they retire. The study found the average worker has only a 40% probability of hitting that mark.
The study used data from Edelman Financial Engines, a large financial management company. The data included 401(k) balances and contributions, salary and demographic information. Using the data, they ran simulations projecting workers' ability to afford their expenses in retirement, like health care.
"It was a good opportunity to see what people are actually doing rather than using surveys or using more aggregated sources of data," Ravina said.
How to avoid falling short
Nearly 10% of workers make early withdrawals from their retirement accounts, which took a toll on their savings, the study found. Many of these people cash out when they change jobs, Ravina said.
This has a dual effect: They have less money in their accounts and earn less interest as a result. She said legislation that would allow people to automatically roll over their retirement accounts when they change jobs could cut down on these retirement "leakages."
Unless there's no other choice, Ravina warned against withdrawing money from a 401(k) because of the huge effect it has on your ultimate retirement savings.
People also pull money out of the stock market during downturns. Those who don't reinvest quickly enough to take advantage of the rebound pay the price during retirement, Ravina said.
"People that have a higher proportion of their portfolios invested in stocks rather than bonds or cash reach retirement age with higher wealth," Ravina said.
Ravina suggested that people should start saving as early as possible for retirement to take advantage of the powerful effects of compound interest.
"Even if it's a small job or a temporary one it's important to start immediately saving for retirement," Ravina said.