Are You Still on Track for Retirement?

The Great Recession has devastated the retirement dreams of the average American. Per the Federal Reserve Board’s Survey of Consumer Finances (SCF) for 2010, the median net worth of all American households fell by 38.8% between 2007 and 2010, from $126,400 in 2007 to only $77,300 in 2010. The decrease was largely due to a broad collapse in home prices caused by the bursting real estate bubble. Since the ability to retire depends on amassing a sufficient net worth before retirement, the average American will need to work longer before retiring, or will need to scale back his post-retirement lifestyle. But these are just averages. The more important question for you is: “Are you on track for retirement? Or, has your ability to retire as you’ve dreamed been devastated by the effects of the Great Recession?”

A good method to determine if you are on track for retirement is to determine your net worth, and to then compare your net worth to the expected net worth of a person your age with your annual income. You may find you are an Average Accumulator of Wealth (AAW), which is a measure of wealth coined by Thomas J. Stanley and William D. Danko in their fascinating book entitled “The Millionaire Next Door: The Surprising Secrets of America’s Wealthy” (1996). If so, you are on an average track for retirement. Or, you may find that you are an Under Accumulator of Wealth (UAW). If so, you have a low net worth based on your age and income, and you are at risk of not having enough for retirement. On the other hand, you may find yourself to be a Prodigious Accumulator of Wealth (PAW). If so, you have a high net worth based on your age and income, and you will likely enjoy having more choices for retirement. You could use these choices to retire early, or to enjoy a more expensive lifestyle during your retirement.

Here's how to use this method to determine your status on the track to retirement.

The first step in determining if you are on track for retirement is to determine your net worth. “Net worth” is equal to the total value of your household’s assets minus the total value of its liabilities.

To determine your net worth, first add up the value of your assets, including: stocks and stock funds; bonds and bond funds; cash (bank accounts, CDs, money-market funds); retirement accounts (IRAs, 401Ks, 403Bs, SEPs); annuities; primary residence; other real estate (vacation home, land, timeshare); art; collectibles (coins, stamps, guns); jewelry; cars; boats; airplanes; and other assets. Then, add up the value of your liabilities, including: mortgage; home equity loan; student loan; credit card debt; car loan; and other debts. Finally, calculate your net worth by taking your assets and subtracting your liabilities.

For example, assume Mr. Employee lives in a $200,000 house, has a savings account with $3000 in it, owns $10,000 in CDs, has $100,000 in stocks in a taxable account, and $80,000 in IRAs. He also has a first mortgage of $120,000, a home equity loan of $20,000, a car loan of $5,000, and $8,000 in student loans. In this example, Mr. Employee has total assets of $393,000 including his house, savings account, CDs, stocks and IRAs. He has total liabilities of $153,000 including his mortgage, home equity loan, car loan and student loans. Therefore, his net worth is equal to $393,000 minus $153,000, or $240,000.

The second step in determining if you are on track for retirement is to determine your household’s annual income from all sources. To determine your annual income, add up the income from these sources: wages; self-employment and business income; taxable and tax-exempt interest; dividends; capital gains; pensions and withdrawals from retirement accounts; Social Security; alimony and other support payments; and miscellaneous sources of income for you (and your spouse or partner). It may be convenient to review your last income tax return, unless you have had recent substantial changes.

For example, assume Mr. Employee has annual wages of $50,000, taxable interest of $1000, and dividends of $2000. He is not married. In this example, Mr. Employee’s annual income is $53,000.

Once you have determined your net worth and annual income, you are ready to compare your net worth to the expected net worth of a person of your age with your annual income. To determine your expected net worth, take one-tenth of your age and multiply it by your annual income from all sources. If your actual net worth is roughly equal to your expected net worth, then you are considered to be an Average Accumulator of Wealth (AAW), according to the terms coined in “The Millionaire Next Door”. If your net worth is significantly lower than your expected net worth, you are considered to be an Under Accumulator of Wealth (UAW). If, on the other hand, your net worth is significantly higher than your expected net worth, congratulations! You are considered a Prodigious Accumulator of Wealth (PAW).

In the above example, if Mr. Employee is 45 years old, his expected net worth is 0.1 * 45 * $53,000 = $238,500. Since this is roughly equal to his actual net worth of $240,000, Mr. Employee is an AAW. He is on a solid track towards retirement, but he is unlikely to be able to retire early and will likely need to carefully watch his retirement lifestyle to make sure his expenses stay within his expected income.

If Mr. Employee is instead 55 years old, his expected net worth is 0.1 * 55 * $53,000 = $291,500. Since his actual net worth of $240,000 is significantly lower than this figure, Mr. Employee is an UAW. In this situation, Mr. Employee should try to increase his retirement savings while he is still working, and he may need to work beyond his normal retirement age of 65 or scale back his post-retirement lifestyle.

On the other hand, if Mr. Employee is instead only 35 years old, his expected net worth is 0.1 * 35 * $53,000 = $185,500. Since this is less than his actual net worth, Mr. Employee is a PAW. Since he has managed to save more than an average person of his age and income, he will likely have more choices for retirement, and may consider retiring early or living a more luxurious post-retirement lifestyle.

As these examples indicate, your position on the track to retirement depends mostly on your age, net worth, and annual income. The older you are, the more you need to have set aside to be well prepared for retirement. By the time you reach the “normal” retirement age of 65, you should expect to have a net worth of about 6.5 multiplied by your annual income if you are an Average Accumulator of Wealth.

Of course, the method for determining your path to retirement presented in this article is generalized, and does not take into account individual situations. If you plan on living a relatively simple and frugal life after retirement, you may be farther along on the track for retirement than this method suggests. On the other hand, if you envision traveling the world after retirement, or relocating to Maui, or taking up expensive hobbies, you will likely need to ensure that you are a Prodigious Accumulator of Wealth.