If you have ever looked for retirement planning advice online, you have likely found an endless supply of articles that just regurgitate many of the same old generic adages. While sound planning principles may not change much (if at all) over time, 3 of the most consistently repeated "rules of thumb" really shouldn't be presented as "sound" advice at all. First of all, everyone's circumstances, needs, and desires are unique, so trying to offer a blanket approach to financial planning is doomed to start with. Have these "advice" articles considered if you are single or married, intend to spend all of your savings before you die, want to leave certain amounts to family, your tax situation, how much it really costs you to live (wants and needs), your medical history and/or life expectancy (based on your family history), etc.?
No, they have not. The list of factors that really need to be considered for reliable financial/retirement planning is extensive, yet these articles don't consider any of them. Who are they really meant to help - or are even capable of helping? To try to be fair, let's at least take a closer look at these recommendations to see if they could be considered even directionally correct.
• Plan On Replacing 75% Of Your Salary In Retirement.
Are You Sure? Many articles suggest that you should plan on replacing 70% - 80% of your gross salary in retirement,
so we split the difference. This would mean that a couple earning $150,000/year should have ~$2.8M saved for
25 years of retirement (75% of $150k = $112,500, times 25 (years)).
In general terms, a 60 year old couple with a combined income of $150,000 per year, using the Standard Federal tax deduction, may pay ~11.5% in Federal taxes (~$10,500). This tax amount accounts for ~$26,000 of common pre-tax deductions such as employer sponsored health care ($6,000/year), 401k savings ($15,000/year, or 10% of salaries), health care spending accounts ($5,000/year), or other elective deductions. This leaves a take-home amount of
$113,500 per year. Let's say that their expenses in retirement may be only 75% of that (no more saving, no kids, no work related expenses, etc.) or ~$85,000/year. If their expenses increased at an average inflation rate of 2.75%/year, they budgeted perfectly and spent their last penny on the day that they died (they won't), and they knew that they would both die exactly 25 years after retiring (not likely), they would need $1.85M in savings to get through retirement (assuming a return of 5% on savings until age 70, and 3% thereafter). Almost. Actually, it would be closer to $2.17M because ~$320,000 would be needed to pay for taxes on annual withdrawals (RMD's) from Traditional 401k/IRA savings.
This is already $630,000 less than originally recommended.
However, they are also likely to be eligible for Social Security benefits. The average benefit is approximately $2,000
per month, providing them with annual S.S. income of $48,000/year ($2,000/month each). An annual S.S. COLA of 1.7% would increase this amount over time. Up to 85% of that income is taxable (likely, once their RMD's are counted as income) and the tax amount has been accounted for above. This means that they would need ~$37,000/year from savings to pay expenses of $85,000 ($85,000 - $48,000). With inflation adjusted expenses, they would need to have $1.16M saved for retirement. That's $1.01M less than the $2.17M stated above, and $1.64M less than the $2.8M recommended in the advice article! Just imagine trying to save $2.8M when you may only need ~40% of that!
Even if the article suggested saving 75% of your net salary, rather than gross salary, using the example above,
that would still amount to saving $2.1M, when roughly only 55% of that may be needed!
This is a simplistic example, with a lot more details that could be considered, but believing that you will need savings that will replace 75% of your gross salary in retirement is most likely misleading. It's not your salary that should be a driving factor for retirement saving, it's how much you intend/need to spend in retirement. This is why it is crucial to run your own numbers, and not follow generic advice or benchmarks.
• Use the "4% rule" for a savings withdrawal strategy in retirement.
Why is anyone even still talking about the "4%Rule" (which, after 30 years, was recently revised to 4.7%)?
The severe limitations of this "rule" (which is not a rule at all, but was intended only as a guide) have been written about many times, and yet, financial advice articles persist in suggesting it. Besides the fact that it is based on outdated and prohibitively rigid assumptions (e.g., a 60/40 portfolio, bonds earning 5% every year, no variability at all in expenses or withdrawals for any year), there's no need to follow a set withdrawal percentage to have your money last through retirement in the first place. In addition, what good is this notion if 4% isn't enough to pay your bills? You don't need such a rigid rule to follow to not run out of money, and trying to find a magic withdrawal % is really an amateur move as it's only part of a much larger equation. No financial adviser worth their fee will ever advise you to blindly follow such a rule/concept. Here's an example of why a varying, and even fairly large, withdrawal rate can still meet your needs:
A couple retires at age 65 (both are the same age), with $1.2M in retirement savings, earning 5% until age 70, and then 3% thereafter (a reasonable approach). They will wait to claim Social Security until age 70, when both will receive a Social Security benefit of $2,750/month (Their FRA benefit was $2,000/month, which becomes $2,750 by waiting until age 70). Their expenses are $85k/year and inflation is assumed to be 2.75%.
For the first 5 years they will rely only on retirement savings to pay expenses. Their withdrawal rate will be ~7.5% - 9.9% for those years (enough to account for taxes on the withdrawals). At 70, their withdrawal rate will fall to ~3.5%, since Social Security income will begin. From then on, the withdrawal rate will increase slowly, year by year, because their expenses will increase with inflation, but their savings will decrease, requiring them to withdraw a larger percentage of the total each year (Social Security isn't enough to pay their expenses, and they're withdrawing more than the 3% they're making). At age 80, they will withdraw ~7.3% of their savings, and at age 85, they will need to withdraw ~13% of savings. Will their money last until they reach age 90 (a reasonable life expectancy). Yes! With a little over $200k in savings. You may want to have a little more cushion built in, but it is clear that sticking with a 4% withdrawal rate, even inflation adjusted (which would be 7.6% after 25 years), is not necessary.
The moral: your exact withdrawal rate shouldn't be a focal point as long as you can afford to live your life. A comprehensive financial plan will show you what is needed, so that you can ignore all of the generic "rules of thumb", assumptions, and benchmarks that are meant for everyone else and no one in particular. You're smarter than that.
• Wait Until Age 70 To Claim Social Security - Or Claim At Age 62?
The best answer may be somewhere in the middle, but everyone's circumstances and needs are unique, so only you know the answer to this. The best course of action is to make sure that you understand all of your options so that you will be comfortable with your decision in the long run.
In general, the earliest that you can start claiming Social Security is at age 62. However, your benefit is reduced by ~8% for every year that you claim before your Full Retirement Age (age 66 if born before 1960, otherwise age 67). If you delay claiming until after your Full Retirement Age, your benefit will increase by ~8% for every year that you wait,
up until age 70 when you would reach your maximum benefit amount. This increase in benefits is why you see so many recommendations to wait until age 70 to claim Social Security.
While this information is accurate, it is too simplistic to act on by itself. Roughly speaking, the break even point between claiming at age 62 and receiving smaller checks, or claiming at age 70 and receiving your maximum benefit amount, is around age 80-81. Rather than basing your decision on a benefit amount alone, you should also consider
if/when you will need Social Security to help pay monthly expenses, and your life expectancy. If you are in good health, will not need to rely on Social Security for income before age 70, and your family has commonly lived into their 80's, waiting to receive the largest benefit possible may be a good idea. If all of those considerations are not true, it is best to adjust your claiming strategy based on your needs, health, and life expectancy. If you are married, there are several additional strategies to consider (e.g., Spousal benefits and Survivor benefits), depending on your respective ages and individual benefit amounts, that may help you to maximize your income potential. The Social Security website (www.ssa.gov) can help to explain your options in detail. Make sure to take your time making this decision as it will affect the income for both spouses for the rest of your lives.