There are many things to think about when it comes to retirement. There is Social Security, investments, budgets, lifestyle, travel, grandkids, and Medicare, just to mention a few. Because of all the moving parts, it can often be difficult to gauge how prepared we actually are for retirement.
And I know that “prepared for retirement” can mean a lot of things to different people but for this article let’s assume that “prepared” means that you’ll be able to maintain the same standard of living as before.
In 2017, The Center for Retirement Research at Boston College published a study that concluded that more than 50% of Americans are not on track to be able to keep up their current standard of living in retirement. Now, this can be hard to verify because it is often true that retirement income is less than pre-retirement income. But for some people, their retirement expenses are lower than their pre-retirement ones. For example, some people pay off their mortgage by retirement or their kids move out which lowers their income needs. That being said, I do agree that not everyone is prepared for retirement
The most interesting part of the study was when they tested people’s “sense” of how prepared they are for retirement. They found that 57% of people accurately predicted if they were on track to maintain their standard of living in retirement. The big pitfall for this group was the fact that most of them accurately predicted that they were not prepared for retirement.
Of the remaining population, they found that 19% were overconfident and 23% were not confident enough. This means that about 19% of people think they’ll be able to sustain their standard of living in retirement but probably won’t be able to, and 23% don’t think they are ready but actually are.
The next question that the researchers searched for was what made people overconfident and what made people too worried.
They found that those that owned their home and had a monthly pension from their jobs were more likely to be too worried. Many of them underestimated how valuable a fixed monthly income can be as well as how much cash they’d gain access to from either downsizing or a reverse mortgage.
On the other hand, those that had a 401(k)-like retirement plan were more likely to be too confident. Those in a 401(k)-like plan are much more likely to have the behavioral finance bias of “wealth illusion.” It is easy to feel rich when you see hundreds of thousands of dollars in your 401(k), but it is much harder to see how much actual income that amount will provide over a long retirement.
It was also found that those who had high income were also more likely to overestimate their retirement. They suspect that this is caused by the fact that as you earn more money (and generally have a higher standard of living), Social Security will provide a smaller percentage of your living in retirement. Consequently, higher earners are responsible for a larger portion of their retirement income.
This is not because high earners actually receive a lower dollar amount from Social Security, but because they max out their benefit.
For example, the maximum Social Security benefit in 2020 at full retirement age is $3,011/month. If you are used to a lifestyle of $4,000/month, then that benefit will cover a significant portion of your living. Now, if you have a lifestyle of $10,000/month, you will have to supplement a lot from your savings.
Conclusion
Retirement can be an incredible period of life but an amazing retirement rarely happens by accident. Good planning rarely happens by accident. I have seen how a little attention to your finances now can save a whole lot of stress and worry later. Start today.