The litany of alarming retirement statistics is seemingly endless in recent years. Depending on who you ask, the current state of retiree savings is a “fiasco“, a “disaster“, a “nightmare“, or a “time bomb“. By the worst estimates, as many as 92% of Americans are failing to meet their savings targets for retirement, with even the more optimistic measures indicating a 50% shortfall. Regardless of the projections, the facts of the matter are stark—roughly a third of workers have no retirement savings or pension benefits, including 15% of those aged 60 or over. For that latter 15%, full retirement at the traditional age is obviously an unrealistic goal.

With traditional pensions becoming an endangered species (and many of the surviving pensions suffering from significant underfunding), combined with the uncertain future of Social Security and other federal benefits, it’s little surprise that a full 40% of Americans don’t think they’ll ever be able to retire. And in many ways, the concern is justified. In our prolonged low-interest-rate environment, it becomes much more difficult for individual savers to meet their target returns. Even top pension funds are scrambling to keep up, leading some managers to take creative measures in order to increase their investment returns.

Amid the constant media hysterics, it seems like many workers haven’t even bothered to try saving for retirement, intimidated into inaction by endless predictions of doom. Perhaps not surprisingly, those who are the worst off are those who have the least hand-holding at their place of business—more than 70% of those who have access to 401(k) plans at work participate in those plans, while fewer than 10% of those without plans save for retirement on their own. Going it alone is, apparently, an incredibly daunting prospect for America’s workers.

Put all of the above factors together, and the predictable result is that the USA ranks just 19th out of 34 OECD nations in terms of retirement readiness, according to Natixis—behind France and just ahead of Slovenia.

Retirement Index Score

While it may be easiest to throw up one’s hands and simply give up, the retirement shortfall is far from insurmountable. For the most part, workers have, in fact, been given the tools they need to succeed. However, given the looming challenges, retirees can’t afford to be cavalier or to squander those tools that they do have.

We’ve compiled a simple list of tools that will enable prospective retirees to effectively increase the risk-adjusted return on their retirement assets. Maximizing the potential benefits of each of these tools could help solve the retirement “disaster” that we supposedly face, allowing us all to enjoy our standard of living for years to come.

Starting Early

The simplest advice is often the most difficult to follow. By far, the single most important thing that any of us can do is to simply begin saving for retirement as early as possible; unfortunately, our brains don’t want us to do so. In general, our survivalist brains are very good at seeing what’s immediately in front of us, but planning for a distant and amorphous future is a task that proves exceedingly difficult.

Difficult or not, however, the task is essential. Once we’ve fallen behind on our retirement savings goal, it can be nearly impossible to catch up, at least not without significant compromises. Consider the two hypothetical individuals below, one of whom starts saving at age 30, one who waits until age 40. Both have decades of prime saving years ahead of them, but their outcomes are vastly different.

Saving Early

In order to be as well off, Saver B would have to save nearly twice as much per year as Saver A in order to achieve the same outcome at retirement age. For those of us who are on tight budgets (which, these days, is nearly all of us), it can be extremely difficult to find that kind of extra wiggle room. This is the importance of saving early; the longer we wait, the more we will have to save in order to meet our goals, exponentially so.

In order to get on the right path quickly (and to stay there), working closely with a financial planner can be key. According to research, the average retirement wealth of those who used planners and had estimated their retirement needs was nearly $250,000, while those who had neither engaged a planner nor estimated retirement needs saved just more than $62,000 on average. Engaging the advice of an impartial observer can help to overcome the brain’s natural tendency toward procrastination, helping to get on the right path early. 

The most important task is to know your target; as Yogi Berra once said, “you’ve got to be very careful if you don’t know where you’re going, because you might not get there.” Of course, it’s inevitable and in fact potentially desirable that our goals and targets will change over time. But if we don’t have a plan in place to begin with, then we won’t be able to determine how shifts in our life circumstances should change our savings plans and retirement goals.

Tax-Deferral

Even if we don’t start early, we can still take advantage of the kindness of the federal government in order to meet our retirement goals. To help encourage retirement savings, the IRS has allowed tax-deferral benefits on a wide variety of retirement plans, most notably 401(k) plans and IRAs. This tax deferral allows savers to earn significantly more compound interest than they would in a taxable account, amounting to a sizable benefit over time. This compounding is at its most powerful when combined with a “save early, save often” strategy, as is shown below.

The following chart shows the effective (after-tax) retirement balances of four different workers, all of whom have determined that they need a nest egg of $500,000 at retirement (age 65), with the ability to save $5,000 per year during their working years.

Worker A starts saving his annual $5,000 at age 40, and places all of his investments in a taxable brokerage account. Worker B also starts saving at age 40, but directs his savings toward a tax-advantaged IRA instead. Worker C starts investing in a taxable brokerage account at age 30, while Worker D also starts saving at age 30, directing it all toward his IRA. Assuming a 7.5% annual investment return, all taxable at an ordinary tax rate of 35%, we see the following results:

Retirement Savings

By the retirement age of 65, only Worker D—who both saved early and maximized his tax-deferral benefits—has accomplished his goal. By waiting too long to start saving, Workers A and B fell woefully short, with Worker A only making it about halfway to his goal. Worker C, who started early but did not take advantage of tax-deferred accounts, came close but did not quite meet his goal.

The ultimate impact of maximizing the two tools mentioned above is to lower the required return on retirement assets, generally meaning that less risk needs to be accepted in order to meet retirement goals.

Required Return

Worker D can meet his retirement goal with an average annual return of just above 6%, while Worker A would need more than double the annual return. That can’t be achieved without accepting a significant amount more risk, which puts Worker A behind the eight ball from the start.

In a low-return investing environment, retirees simply cannot afford to squander the opportunities that are afforded them. Harnessing the exponential power of compound interest and of tax-deferral is absolutely essential in order to avoid the disastrous retirement outcomes that so many media pundits have predicted.

Other Considerations

While starting early and maximizing tax advantages are the most important tools, there are other considerations that can make a difference on the periphery. When managing retirement investments, regularly rebalancing a portfolio to ensure consistency of asset allocation can dramatically decrease the volatility of a retirement account.

Furthermore, “asset location” strategies can improve on the benefits available from tax-advantaged retirement accounts. By placing different types of investments in different types of accounts, an asset location strategy aims to take advantage of intricacies in the tax code to further improve risk-adjusted returns.

It is important to recognize that while tax-deferred retirement accounts do delay the tax bill until retirement years, all taxes on IRA or 401(k) withdrawals will be charged at ordinary income rates, rather than at favorable long-term capital gains rates. Therefore, to the degree possible, long-term investments which can be expected to generate capital gains (like growth stocks) should be kept in taxable accounts, while tax-inefficient investments (like bonds) should be held in tax-deferred retirement accounts.

The benefits from rebalancing and “asset location” strategies may not be nearly as substantial as the two primary strategies mentioned above, but for a nation facing a retirement “time bomb”, every little bit counts.

Nearly every development in the retirement world over the last two decades has had the impact of placing more of the burden on the employee, rather than the employer. This new responsibility can be intimidating, and it’s clear that many workers have shied away from that responsibility, waiting or hoping for a magical government policy to rescue their retirements for them. But magical thinking is neither realistic nor necessary; the retirement “crisis” is, in large part, a self-inflicted wound for American workers.

By taking a series of simple steps, a happy and prosperous retirement is still well within reach. Define your goals, start saving early, take advantage of tax-deferred accounts, and you’ll be well on your way.