The magic question when saving for retirement revolves around how much you will really need to save to have those savings last for at least 25 years (assuming that you retire at age 65). Of course, creating a comprehensive financial plan will help to answer this question with the most detail and reliability, but many people initially look for a quick guide to at least get the conversation started. On any given day there are countless articles focused on suggesting generic benchmarks for anyone and everyone to use as retirement savings goals, with 99% of that "information" simply being regurgitated from one article to the next. This is supposed to be helpful. The thirst for these articles is why financial institutions like Fidelity have come up with their own age-based savings benchmarks that suggest, for example, that you should have 10x your current annual salary saved by age 67. This amount is meant to replace 45% of your current income (according to Fidelity), with Social Security providing an additional amount. For someone with a $100,000 salary this would require $1M in savings. Assuming a conservative 3% return, 2.5% inflation rate, and 1.5% Social Security COLA's, this would allow for a $38,000 initial savings withdrawal (increasing each year to keep up with inflation) for the savings to last until age 90. Since the average Social Security benefit is ~$15,000/year, you would have ~$53,000 in total income, or ~$51,000 that is spendable after taxes. Would $51,000/year (inflation adjusted), or 51% of your pre-retirement salary, be an appropriate amount to live on for 25 years of retirement if your current salary is $100,000/year? Fidelity says it is. Your mileage may vary.
Another benchmark often mentioned in financial advice articles (and repeated by many Financial Advisers) is to plan on replacing 80% of your gross annual income in retirement. This is vastly different than Fidelity's recommendation and includes no mention of how Social Security would figure into this plan. If your current income is $100,000 (using all the same assumptions as above) this would require $2M in savings and would provide an ~$80,000 initial withdrawal (~$74,000 after taxes) for those savings to last until age 90. This is more than double the result above. If you include the same $15,000 Social Security benefit used above (to make these examples apples-to-apples), that will provide a spendable income of ~$89,000/year (89% of pre-retirement income). Would you need a spendable income of $89,000/year in retirement, especially when you were living on much less (after taxes, savings, health insurance, etc.) before retirement? Why try to save far more money than would probably be necessary?
The two savings benchmarks above provide vastly different results for equal salaries. How is someone supposed to reconcile the disparity between a $1M savings recommendation that supports a $51,000 net income, and a $2M recommendation that supports an $89,000 net income? Is one way more accurate than the other? Who's right? What if your expenses are only $45,000/year - why save 10x your income, or 80% of your salary? This is the problem with generic benchmarks - they are meant to apply to everyone, but no one in particular, and even the professionals can't agree on a similar method. The real question, with everyone's situation, wants, and needs being unique, is why do they even try? More importantly, why does anyone pay attention to flawed information? Instead of being misleading, why not encourage people to do their due diligence to find the best possible answer for reaching their goals? Answer - because that information won't generate clicks. Or would it? Would you rather click on an article that offers the dumbed down information above, or on one that guides you to resources that will help you to find the answer that is right for you (and not just by seeking the help of a financial adviser)?
Rather than relying on random benchmarks that use misguided assumptions while neglecting essential information (e.g., taxes, personal needs, etc.) a little due diligence will likely help you to be better prepared. There is no way to accurately predict the future - even with a thorough and individualized financial plan - so you need to protect yourself as best you can from unexpected outcomes instead of trying to calculate an exact savings amount. Here are ten steps to take that might help:
• Create an individualized financial plan based only on your unique circumstances. Whatever may apply to everyone else has nothing to do with you. Include all "wants" and "needs" in your plan.
• Retire based on your assets, not your age.
• Choose the age to start Social Security benefits carefully. If married, make sure that you understand the best strategy for both of you, individually, and together.
• Diversify your investments to help protect against various types of market downturns. This includes using proven dividend ETF's as one part of your investment strategy - income flow is important.
• Be aware of the expense ratios for any mutual funds (don't give up more of your money than you need to!).
• Do Not use a single rate of return for all years in your financial plan. Using the same rate for all years rather than varying rates produces inflated, unrealistic results. (See our Blog post from 9/3/21)
• Know and track your expenses, cash flow, and goals annually (before and after retirement). Adjust as needed.
• Be prepared to pay taxes on distributions from tax-deferred retirement funds (and possibly on a portion of Social Security benefits, depending on your total income).
• Do not underestimate health care costs. In fact, this is one area where you should overestimate!
• Carefully consider the most efficient strategy for using various funds (cash, taxable investments, retirement savings, etc.) to pay expenses. It's often most advantageous to use a mixture of fund types in any given year rather than just one type at a time in order to minimize taxes.
Retirement planning is not as arduous as some make it out to be, and it's more than worth a few hours of your time to set it up properly. It is mostly common sense combined with a realistic outlook of what is likely to happen/change in the future. No crystal ball needed, just careful forethought. If you have "x", earn "x", and spend "x", with a little variation of earnings and spending in any given year (be conservative, not optimistic), "y" will be the outcome. Adjust your savings and expenses until you are happy with the long-term result.
As with anything else, having the right tools and information available to help you will make this process easier
and faster than you might have thought possible. Just don't be so eager to listen to what others may be doing
and/or suggesting. They don't know anything about you and free advice can prove to be very costly -
wrong answers can be expensive.