Millennials are now the largest generation of Americans, surpassing the Baby Boom generation in sheer numbers.  Their financial situation is gaining much attention, with concerns about student debt, modest recovery of the job market for millennials, and delay of home purchases and saving for retirement.

Many millennials are entering their late 20s and early 30s, and it’s inevitable that they would turn their attention to saving for retirement. They may be asked to enroll in a 401(k) plan at work for the first time. They may be particularly focused on building retirement security if they see their parents – the baby boomers – approach their retirement years with inadequate retirement savings.

How much should millennials save for retirement? The fact is, any calculation of a retirement savings goal makes a number of assumptions about the future, and the farther away that future is, the more likely it is that the assumptions will turn out to be wrong. For example, the following assumptions need to be made to calculate a retirement savings target:

• Rate of return on savings, which depends on the assumed allocation of assets between stocks, bonds, and other investments, as well as the level of assumed investment expenses
• Inflation rate
• Salary growth rate
• Retirement age
• Household structure at retirement (single, married, presence of dependent children or parents)
• Amount of Social Security benefits (which depends in part on the household structure)
• Amount of matching contributions from employers, if any
• Amount of existing savings
• Expected living expenses at retirement, the largest of which will most likely be mortgage payments and medical premiums
• The income tax rates at retirement, and whether savings are invested in traditional retirement savings accounts or Roth IRAs or 401(k) accounts.

It’s quite easy to imagine many people throwing up their hands in frustration, saying “how should I know,” given that these assumptions must cover the next 50 years or so.

Millennials are at the age where any calculation of a retirement savings goal is, at best, a guestimate and more often is simply a shot in the dark.

A pessimistic perspective

A recent study by NerdWallet¹ reveals that 22 percent of pay could be the new retirement savings goal for millennials, including the employer’s match. Adding this to all the financial issues mentioned at the beginning of this article, it’s no wonder so many millennials may feel be feeling stress about their financial future.

But will millennials really need to save a total of 22 percent of pay for retirement? The answer depends on the degree of optimism or pessimism built into the assumptions listed above.

The NerdWallet analysis resulting in the 22 percent savings target assumes a 25-year-old currently making the median wage of $40,000 per year will retire at age 67 and will need to replace 80 percent of her income for a comfortable retirement.

These last two assumptions may or may not be too pessimistic, depending on the individual’s goals and circumstances. For instance, many millennials plan to work in their retirement years and retire later than age 67 (although it remains to be seen if they’ll be able to find work). And many retirees are quite happy living on reduced incomes in exchange for their retirement freedom.

The NerdWallet analysis resulting in the 22 percent savings assumes annual stock market returns will fall to 5 percent per year from the historical average of 7 percent. NerdWallet also calculates that the 22 percent target will drop to 13 percent of pay if stock returns are 7 percent per year.

Most important, its calculations assume millennials will receive nothing from Social Security, a position that may prove to be way too pessimistic. The Social Security trust fund could be completely exhausted and beneficiaries could still receive about three-quarters of their scheduled benefits, according to the 2016 Social Security Trustees Report².

All told, NerdWallet’s 22 percent figure is based on a number of assumptions that lean toward pessimism.

A more optimistic perspective

The Boston College Center for Retirement (CRR) also recently provided retirement savings guidelines that can apply to millennials³. It calculated guidelines for a number of situations depending on earnings level, the age the worker started saving for retirement and the assumed retirement age. For example, for a 25 year-old middle-income earner, these savings targets are most applicable according to CRR:

• To retire at age 62: Save 15 percent of pay
• To retire at age 65: Save 10 percent of pay
• To retire at age 67: Save 7 percent of pay
• To retire at age 70: Save 4 percent of pay

Note: Employer matching contributions count toward these goals.

To compare these numbers directly to the NerdWallet analysis, the CRR savings guideline for a 25-year-old who retires at age 67 is 7 percent of pay, a far cry from 22 percent or even 13 percent.

The following CRR assumptions are more optimistic than NerdWallet’s:

• Middle-income earners will need a retirement income of 71 percent of their pay in retirement
• They’ll receive about 41 percent of their pay from Social Security and 4 percent from a reverse mortgage on their home.
• Savings will earn a real rate of return of 4 percent per year. Factoring in inflation brings the total return closer to the historical 7 percent return mentioned in the NerdWallet analysis.
• Retirees will annuitize their retirement savings, which usually produces the highest amount of retirement income compared to other methods of generating retirement income from savings. (By the way, most retirees don’t currently annuitize very much, if any, of their retirement savings.)

All told, the CRR assumptions may lean toward being somewhat optimistic.

How much are millennials contributing toward retirement?

A recent study by Transamerica⁴ reports that the median savings levels for millennials is currently 7 percent of pay, not counting employer matching contributions, which should be counted toward meeting savings targets. For many millennials, contributing the maximum that their employer matches may result in total savings amounts, including the employer match, that fall between the NerdWallet and CRR analyses and might represent a reasonable and realistic compromise.

The Stanford Center on Longevity recently published its Sightlines report⁵, which analyzed the steps that Americans of all ages are taking to improve their health, financial security, and social engagement to help them live long and well. We prepared an analysis (unpublished) of the amounts various age groups were saving toward retirement in their employer-sponsored retirement savings plan. The data did not include amounts contributed to IRAs or other savings vehicles.

This analysis shows that in 2013, the contributions (including the employer match) for the 25-34 age group ranged as follows:

• About 55% contributed at least 5% of pay
• About 30% contributed at least 10% of pay
• About 12% contributed at least 15% of pay

Contributions for the 35-44 age group ranged as follows:

• About 63% contributed at least 5% of pay
• About 40% contributed at least 10% of pay
• About 22% contributed at least 15% of pay

Looking at various demographic subgroups, in general the differences are what can be expected:

• males contributed more than females,
• whites contributed more than other ethnic groups,
• married workers contributed more than single workers,
• workers with a college degree contributed more than lower educational attainment levels, and
• the top quartile of earners contributed more than lower earners.

It’s probably safe to say that at least half and possibly up to two-thirds of millennials were falling short in 2013 of the optimistic guidelines prepared by the Boston College Center for Retirement Studies, let alone the more pessimistic guidelines prepared by NerdWallet.

Guidance for millennials

It’s clear that many factors and assumptions go into calculating retirement savings targets, and that the degree of optimism or pessimism built into the assumptions will dramatically influence the results. The best that millennials can do is to pick a reasonable savings target that fits their budget and outlook for the future, using one of the many retirement calculators online or through their savings plan administrator. Then they should be prepared to fine-tune their calculations and retirement plans when they reach their 40s or early 50s.

Challenges for stakeholders

Employers and retirement plan sponsors will want to continually look for ways to increase their employees’ total savings to retirement plans, with a special focus on vulnerable groups that are contributing well below guidelines. Auto-enrollment and auto-escalation features have been successful at increasing contributions. Recent offerings from financial wellness programs may also help workers of all ages find money in their budgets to save for retirement.

Employers will want to monitor the success of these programs. They can also prepare customized assessments of their employees’ progress towards accepted retirement goals, given how much each employee has saved so far and the specific features of employer’s retirement program.

It’s probably safe to say that most workers aren’t saving enough for retirement, so any increase is progress in the right direction.

Citations:

1. Study: Millennials May Have to Save 22% of Yearly Income for Retirement if Market Returns Drop, by Jonathan Todd, NerdWallet, September 28, 2016.
2. The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, Social Security Administration, June 22, 2016.
3. How Much Should People Save?, by Alicia H. Munnell, Anthony Webb, and Wenliang Hou, Boston College Center for Retirement Research, July 2014, Number 14-11.
4. Perspectives on Retirement: Baby Boomers, Generation X, and Millennials. 17^th Annual Transamerica Retirement Survey of Workers, by the Transamerica Center for Retirement Studies. August 2016.
5. The Sightlines Project, Stanford Center on Longevity, February 2016.