Will your 401(k) be enough for retirement?

Assume you need to replace 85% of your pre-retirement income. Where will it come from? According to this article from the Wall Street Journal, Social Security will account for 40% of the post-retirement income for those currently eligible for retirement. No one under 30 (under 40?, under 50?) should plan for this to be available. That means all of post-retirement income will have to come from pensions and self-directed investments. Pensions are hit-or-miss and are likely to become less and less prevalent. This leaves 401(k) and IRA.

I'll assume a salary increase of 3% a year, which does not include promotions (but, unfortunately, is less than the average inflation of 3.31% over the last 30 years). Your salary will be 242% of what it is now. If you have 30 years until retirement, you'll have to have a post-retirement income of just over twice your current income. Assuming, as the WSJ article did, a 6% post-retirement return, you'll need a retirement account worth 34 times your current income.

The article referenced above recommends contributing 12 to 15% into the 401(k) including employer match. The average return for high-risk stocks (which you should be in if you've got 30 years to retirement) are just under 10%, but that's probably unrealistic. If you invest in mutual funds, which is predominant in 401(k) plans, you'll give back 1-2% a year in management fees. Let's assume 7% a year growth. Including the 3% salary growth, investing 12% a year in the 401(k) will result in 16.5 times your current salary in 30 years. Investing 15% results in about 20.8 times your current salary. In other words, your 401(k) will only provide 50 to 60% of your retirement needs with a 12 - 15% contribution.

Where does the rest of the money come from? Consider a Roth IRA. The current contribution limit is $5000/yr (not guaranteed to continue at this rate). Using the above 7% return on aggressive stocks, the Roth IRA will be worth approximately $500,000 after 30 years of maximum contributions. This number is fixed, so how much this will contribute to your post-retirement income depends on your current salary. The multiple of current salary could be anywhere from 5 (current salary is $100k/yr) to 10 or more ($50k/yr or less), which would account for 15 to 30% of retirement income.

Adding the recommended 401(k) contributions and the Roth IRA, these can account for anywhere between 65 and 90% of your retirement needs. This obviously doesn't add up to enough. If your employer has a pension plan, you can add that by using the projected payout amount divided by your current salary. That number divided by 34 is approximately the percent of your retirement the pension will cover. If you don't have a pension plan, investing more in the 401(k) plan is a way to make up the difference. Every 1% increase in your 401(k) contribution should add another 4% to your retirement account after 30 years.

These numbers aren't exact. A slight change in any of the assumed percentages could make a drastic change in the retirement account value, especially over 30 years. A main assumption made was the 6% return on an account post-retirement. This number may be high. Taking a lower assumption of 5%, you'll need 41 times your current salary (20% more) at the time of retirement. Using the current CD rates of 1.25%, you'll need more. Much more. Digging into your principal during retirement can make up for the expected earnings but the money will only last a finite amount of time.

The take-away from this exercise should be that without Social Security, everyone will need to make up a substantial portion of their retirement. The recommended 401(k) contribution, even paired with maximum contributions to an IRA won't be enough. Additional savings needs to come from increased 401(k) contributions, or a company pension.