Why Retirement Prospects Are Brighter Than They Seem

Average savings data point to meager retirements, but individual savings look better than averages.

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Survey after survey reports that Americans are ill-prepared for retirement. Looking at people's average retirement savings balances, it appears we have set very little aside. The average retirement plan balance is way too small to support meaningful amounts of retirement income.

Retired couple

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True enough. But in looking at 401(k) account balances, it turns out, the story told by average numbers is not the same story told by individual savings behaviors. "It's really impacted by new participants coming into plans," says Jeanne Thompson, a market research specialist and vice president in Fidelity Investments' 401(k) business. Fidelity provides services to some 20,000 401(k) plans with 11.8 million participants.

New participants tend to have zero balances in their new 401(k) accounts and thus drag down the average size of participant savings, she says. At the other end of the spectrum, older employees tend to have the largest account balances. But about two-thirds then leave the plans when they stop working, so these large balances are removed from plan averages. Thompson says about a third of Fidelity's participants roll their balances over to IRAs, a third cash them out as lump-sum payments, and a third keep them in the plans.

Beyond the averages, those younger employees with low 401(k) balances still are decades away from retirement. Also, many of them have lower pay early in their careers. And employees with lower compensation tend to place smaller percentages of their paychecks into 401(k)s than do higher-paid employees. But as younger workers get older, their pay levels tend to rise and so do the percentages of their 401(k) contributions.

Fidelity studies the percentages of 401(k) contributions that people make based on their salary and age. The smallest contribution—less than 5 percent—are made by people in their 20s earning less than $20,000 a year. But when looking at this same compensation band among employees in their 60s, contribution levels have risen to between 8.5 and 9 percent of participants' salaries.

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Contribution rates increase steadily with pay. For employees in their 20s, the rate rises from 4.9 percent for people making less than $20,000 a year up to 12.6 percent for people making more than $150,000. Looking at people in older age groups, there is a similar stair-step increase based on salary. By the time a participant reaches their 60s, contribution rates rise to 14 to 15 percent at higher salary levels.

So, it's clear that older employees are setting aside increasing percentages of their salaries as they age, and that their salary levels are rising as they get older and gain more experience in the workplace. This implied good news for 401(k) account balances is confirmed by studies that Fidelity does of the same participants over time.

The overall averages for 401(k) balances lump together different people at different ages and salary levels. But this second set of studies is of the same people over time. It thus captures the actual trends of rising contribution rates and salary levels, as well as the benefits of accumulated years of investment gains.

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At the end of March 2002, the average balance of plan participants ages 30 to 34 was only $4,600. This average rose in progressively older age groups, and totaled $77,700 for employees ages 55 to 59. Fidelity then looked at these same individuals 10 years later, at the end of March 2012.

Participants who were 30 to 34 in 2002 are 40 to 44 in 2012, and their average 401(k) balance have risen from $4,600 to $78,300. Employees who were 55 to 59 in 2002 are now 65 to 69, and their balances have increased from $77,700 to nearly $245,000. Taking the entire group of participants from 2002 to 2012, the average 401(k) balance of the same group of individuals rose from $54,300 in 2002 to $194,300 in 2012.

Another positive report on the differences between perceived and actual retirement readiness comes from the Employee Benefit Research Institute (EBRI). It has assembled a large database of Individual Retirement Accounts. For the first time, it has looked not just at individual IRA account balances and trends but at IRA balances among individuals, many of whom have multiple IRAs.

While the average account balance in 2010 for all IRAs was $67,438, EBRI says, the average for IRAs combined for each individual account holder was $91,864. So, the picture for individuals is brighter than when just looking at IRA accounts. And as with Fidelity's data on 401(k)s, this more accurate average looks even better when it is adjusted for participants' ages. Looking at the average balances of all of an individual's IRA accounts, EBRI found that it increased from $10,290 for people in their 20s to $170,672 for IRA account holders ages 65 to 69.

The clear message is that if people stick with their 401(k)s and IRAs, their retirement prospects are far more optimistic than the overall averages reported for the industry.