Higher-income households are more likely to overestimate their retirement readiness, according to a new analysis from the Center for Retirement Research at Boston College. The findings underscore the importance of proper retirement planning, even for the wealthy.
While 28% of all households wrongly assume they’re prepared for retirement, middle-income households do a little better – only 26% are overconfident – while high-earning households are the most overconfident, with 32% overestimating their financial readiness.
A financial advisor can help you prepare for retirement. Find a financial advisor today.
Using data from the latest Federal Reserve Survey of Consumer Finances (2019), the CRR’s analysts compared the number of respondents who considered themselves financially at risk or under-prepared for retirement against their retirement assets. Overall, 28% of households that weren’t retirement ready failed to recognize that they were on track to come up short. The center classified those households as “not worried enough.”
“Households that are ‘not worried enough’ are the least likely to change their saving or retirement plans,” the CRR report concludes. “This group accounts for 28% of households, so a significant portion of the population needs to get a better assessment of their retirement income needs.”
According to the Federal Reserve survey, lower-income households earned a median income of $18,000 to $37,000 during 2019; middle-income households earned between $59,000 and $95,000; and high-earning households brought in a median income between $150,000 and $283,000.
Why We Overestimate Our Retirement Readiness
There were three most common misconceptions leading workers to overestimate retirement readiness:
Households With Higher Housing Debt-to-Asset Ratios
This risk comes from rising home values that can lead the homeowner to overlook the amount of debt they still owe on the mortgage. The center found this oversight to be especially strong for high-income households with more expensive homes.
Strategy: A little simple math can help – the equity ratio and the net sales profit. On a home valued at $600,000 with a $400,000 mortgage, the equity ratio is 67%. Any ratio above 50% means the homeowner owes more on the house than they’ll receive from a sale. The net sales profit of $200,000 ($600,000-$400,00) brings the potential cash produced by a sale down to a more accurate value (and still doesn’t include sales commissions and fees).
Relatively Low Balances in 401(k)s and Other Defined Dontribution Plans
Workplace retirement savings plans can create a similar “wealth illusion.” A balance of $100,000 in a 401(k) plan can look like a lot of money, even though it would provide only a small amount of monthly retirement income. This is an overconfidence risk factor, especially for low- and middle-income households, the CRR found.
Strategy: Calculating your potential withdrawal rate – the percentage of your portfolio you’ll withdraw each year – can help put your retirement savings into better context. The 4% rule, for example, posits that withdrawing 4% of your portfolio in your first year of retirement and then adjusting subsequent withdrawals for inflation can safely produce income-adjusted pre-tax income for 30 years. However, a $100,000 nest egg would only generate $333 per month.
Households With Two Earners, but Only One Retirement Saver
Lastly, working couples can overlook the fact that in retirement they’ll need to replace both incomes to maintain their standard of living in retirement. When just one person is saving for retirement, those households were more likely to be “not worried enough.”
Strategy: A retirement income projection from a financial planner can produce a realistic expectation of how much retirement income can come from investments, and couples can adjust their saving or expectations to accommodate that projection. High-earning households should understand that Social Security will replace a smaller share of pre-retirement income.
Retirement can last 30 years or longer, which requires more assets than many people may realize in order to keep up with increases in the future cost of living. The study we detail throughout this article that was conducted by the Center for Retirement Research at Boston College found that high-earning households are the most likely to overestimate their retirement savings. A retirement income and cost projection can help create realistic expectations, for households of all income levels in the U.S.
Retirement Planning Tips
- A financial advisor can be a valuable resource during the retirement planning process. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Maxing out your retirement accounts can help you save more money faster. The limits to how much the IRS allows savers to sock away in their 401(k)s, IRAs and other accounts change, sometimes on a yearly basis. Be sure to stay up to date on these changes, and if you can, increase your contributions as the limits go up.
Photo credit: ©iStock.com/momcilog, ©iStock.com/fizkes