Approaching retirement, Generation X individuals often face a higher risk of financial insufficiency compared to their younger counterparts.
Many contemporary workers find themselves responsible for saving sufficient funds for their retirement, thanks to a shift away from conventional defined-benefit pension schemes. In these systems, employers fully finance regular income payments to retirees. Instead, there's been a shift towards defined-contribution systems, where employees are left to manage the majority of their savings and investment choices.
The generations most affected by this transition are Gen Xers, who are nearing retirement age, and Baby Boomers, some of whom have already reached their 60s. Research indicates that these two generations are more likely than their Millennial or Gen Z counterparts to experience shortfalls in retirement savings due to this shift.
It's crucial to remember that workers from a specific generation are not a homogeneous group. Retirement readiness depends heavily on an individual's saving opportunities and associated risks, which can fluctuate widely and are heavily influenced by an employer's policies.
The aim of the Morningstar analysis was to pinpoint which individuals have the smallest risk of retirement savings depletion and those with the highest risk.
The highest likelihood of adequate savings: Regular participation in a workplace savings plan
Having continuous access to and participation in a 401(k) or equivalent employer-sponsored savings plan for an extended period can significantly increase the chances of amassing sufficient savings and Social Security benefits to meet living and health expenses during retirement.
Only 21% of individuals who engage in this practice may face financial difficulties, predicts Morningstar.
However, there's a problem. Nearly half (47%) of US workers do not have access to such a plan, according to Morningstar's estimations. Moreover, out of the workers who have access, approximately 16% do not participate.
The researchers have expressed concern about a retirement crisis for those who are unable to participate in a defined-contribution plan. They estimate that more than half (57%) of workers who do not participate in a workplace plan may struggle financially during retirement.
The impact of employment: Private vs public sector
If you work in the private sector, your employer has the discretion to offer a retirement savings plan. Large companies generally provide such plans, while smaller firms do so less frequently. Additionally, temporary workers or independent contractors are usually ineligible for participation.
On the other hand, public-sector employees tend to encounter a significantly lower risk of running out of income during retirement, as they are more likely to have defined-benefit pension schemes and access to 401k-like defined-contribution plans, as reported by Spencer Look, associate director of retirement studies at Morningstar and a co-author of the analysis.
The outlook for Gen Xers and Baby Boomers
Morningstar's predictions primarily focus on individuals with a substantial timeframe to save, which older Gen Xers and younger Baby Boomers do not have.
However, for this age group, the underlying principles still apply. Individuals with consistent saving habits, who avoid undermining their retirement savings by withdrawing funds prematurely or cashing out upon job termination will have more favorable retirement prospects due to larger balances.
Younger Gen Xers, born between 1975 and 1980, who have not been saving adequately or consistently, still have the opportunity to make amends, but this is contingent upon their access to tax-advantaged plans and income levels. Morningstar estimates that 48% of Gen Xers do not have access to a defined-contribution plan, and around 79% do not have access to a defined-benefit pension.
A study conducted last year by the National Institute on Retirement Security revealed income to be the primary determinant of retirement savings accumulation. According to the report, savings for Gen Xers is predominantly concentrated among high-earners. The somewhat positive news is that among the Gen Xers who do have access to a 401(k) or similar plan, only 7% choose not to participate.
Major changes required to bridge the retirement savings gap
Labor economist Teresa Ghilarducci, author of "Work, Retire, Repeat: The Uncertainty of Retirement in the New Economy," has long argued that the US's individual-driven retirement system has failed those who have dedicated years of labor but cannot save enough for their retirement.
Politicians have taken some measures to make saving easier, such as introducing new policies like Secure 2.0. Indeed, Morningstar notes that these changes could potentially contribute to lower retirement savings shortfalls for Millennials and Gen Z workers compared to Gen Xers and Baby Boomers, given recent features incorporated into 401(k)s like automatic enrollment and target-date funds.
In the future, there might be more alterations. There's a bipartisan bill called the Retirement Savings for Americans Act, which has advocates in both the House and the Senate. This bill, inspired by a study authored by Ghilarducci and ex-leading Trump financial advisor, Kevin Hassett, could potentially be presented for debate when the new Congress starts in January 2025. This legislation aims to establish a movable, tax-favored retirement savings program for numerous low- and middle-income employees, providing a matching contribution by the federal government.
As expressed by Pennsylvania Republican Congressman Lloyd Smucker, a co-sponsor of the bill, during its re-introduction in October 2023, "Over half of the working force doesn't have access to the tax-favored retirement benefits that wealthier individuals often utilize to save. Furthermore, as the workforce evolves and an increasing number of Americans are classified as 'gig workers,' relying on conventional employer-sponsored plans pushes far too many individuals to miss out."
However, even if this bill eventuality becomes legislation, it's unlikely to provide significant assistance to individuals who are close to retirement at this time. Their best course of action might be to prolong their employment, save as much as they can while still earning a paycheck, and cut back on expenses. This strategy could potentially help them maintain financial stability until retirement.
In the context of retirement savings, investing in a 401(k) or equivalent employer-sponsored plan can significantly reduce the risk of financial difficulties during retirement. However, nearly half of US workers do not have access to such a plan, and out of those who do, approximately 16% do not participate, which could pose a challenge for adequate savings.
Given the shift towards defined-contribution systems, traditionaldefined-benefit pension schemes are no longer the primary source of retirement income for many workers. As a result, investors need to be proactive in managing their savings and investment choices to ensure they have sufficient funds for retirement.
