As a Financial/Retirement Planner, the two most common questions I am asked are, “How much should I have saved so far for retirement?” and “Do I have enough to retire?” While so many advisors, media personalities, scholars, etc. attempt to develop formulas to answer these questions, the reality is the questions are quite simply too difficult to answer utilizing these generic “one rule fits all” approaches.
Saving for retirement can feel like running a marathon without a finish line – a constant and tiring struggle. Lacking a preretirement savings objective can make it difficult to set up a realistic savings plan, determine a retirement budget or even accurately manage your retirement investments. Yet, fewer than half of Americans reported that they or their spouse have tried to predict how much money they will need for retirement, according to the Employee Benefit Research Institute’s (EBRI) 2013 Retirement Confidence Survey.
Factors Necessary in the Retirement Planning Process
The number of variable factors one must consider and account for in the retirement planning process makes it impossible to generically predict a precise retirement income for everyone. We all live lives that are truly unique! However, by taking a closer look at these factors, some within your control (such as your retirement lifestyle) and some subject to outside influences (such as inflation), you can determine their effect on your retirement savings and more accurately predict how much is “enough” for you to comfortably retire.
The easiest question, by far for clients for whom I serve, to answer is, “At what age do you want to retire?” Choosing an age at which you want to retire is the first step in the retirement planning process. If you want to retire by age 50, you will have a vastly different savings plan than someone who plans to retire at age 70, as that person will have 20 years of additional income to add to their savings. If you do want to retire at an early age, starting to save very early is even more crucial; the more years you have between you and retirement, the less you will have to save each month to reach that goal.
Opposite retirement age, the most difficult question to answer for most of the clients for whom I serve is, “What will you do in retirement?” Especially if you are far away from retirement, it can be difficult to imagine what your lifestyle will look like during this unique time in your life. It is very important to identify the activities you intend to enjoy, such as hobbies you expect to pursue, how much you want to travel, if you will pursue part-time work and how frugal you realistically expect to be during this time. Although some costs, such as commuting costs, payroll taxes, retirement savings, mortgage payments, etc. will likely go down during retirement, you will also have more free time to spend your money during retirement. Even if you estimate
everything else correctly, if your budget for a retirement lifestyle is more conservative than the actual retirement lifestyle you live, your savings may not be enough.
The amount you currently have earmarked for retirement will affect the amount and the pace at which you need to continue to save in the future. This includes money you put aside for retirement, such as contributions into your 401(k) or an Individual Retirement Account (IRA), as well as personal investment and savings accounts.
Income and Savings Programs
Not only how much you can afford to save, but also the amount you should ultimately put away, is highly dependent on your income. Most estimates for retirement savings are either a percentage or a multiple of your income, and generally, the lower your income, the higher a portion of it you will need to save.
In addition to your regular income, you should consider any other forms of income you will receive in retirement, such as Social Security or a pension. Your Social Security statement, available through the Social Security Administration, provides an estimate of your retirement, survivor and disability benefits under current law and updates your latest reported earnings. Per the current protocol, you should receive a Social Security statement at age 25 and will receive the statement every five years until you reach the age of 60. At this age, you will then receive your statement annually until you file for benefits. Instead of waiting for the statement to arrive in the mail, you can go online and access your individual statement at http://www.ssa.gov/myaccount.
The discipline you have now, as it pertains to instituting and maintaining a structured savings approach will be another key factor in sufficient retirement planning. Taking advantage of employer-sponsored retirement plans can yield substantial benefits during retirement. If these plans are not available, utilizing a systematic savings approach and funding available non- employer sponsored retirement accounts/plans will be critical to retirement planning success!
Investment Returns and Asset Allocation
When calculating any savings you will incur from harvesting and, potentially re-investing investment profits, you will have to calculate the annual rate of return you expect to have. This includes savings you have already accumulated as well as savings you intend to make in the future, including during your retirement. When estimating these rates, you will want to err on the side of being conservative. When providing financial planning for clients, I utilize historical rates of returns dating back to day one of the markets – this is truly the only unbiased approach in evaluating historical asset class returns.
Of course, the key driver of your overall investment returns will be the way in which you have allocated your investments among the various asset classes. Utilizing an asset allocation that is too conservative may not provide the capital appreciation necessary to outpace inflation and
maintain pace with your expected financial needs in retirement. On the other hand, utilizing an asset allocation that is too aggressive may cause dramatic swings in market value and create losses that are unrecoverable. The takeaway here is to understand your own risk tolerance, time horizon and ultimate income needs in retirement.
Unfortunately, the income you can comfortably live on during year one of your retirement may not be sufficient for year 10, simply due to inflation. As the cost of living rises, so must your estimates of how much income you will need per year to live. Although inflation rates vary over time, it is always safest to assume a higher rate of inflation and save too much rather than assume a generous rate and find yourself with a shortfall.
Predicting your own natural death is, well, impossible. However, ascertaining an idea as to your own life expectancy can help you determine how many years for which you should plan in retirement. According to the Social Security Administration (SSA), an American man at age 55 can expect to live, on average, an additional 28 years. An American woman at age 55 can expect to live, on average, an additional 31 years. (As an FYI, as a financial planner, I assume that each of my clients, male or female will live to be age 90). Since most people estimate their retirement savings based on how much they will need each year, it is important to estimate how long you will need to depend upon your retirement savings.
Of course, life expectancy coincides with retirement duration. According to Statisticsbrain.com, the average duration of retirement for an individual retiring in 2015 is 18 years. As noted earlier, I assume each of my clients will live to be, at least age 90. Thus, if a client desires to retire at age 65, this equates to planning for 25 retirement years. The most important point here is to understand the average retirement duration but also be conservative in your planning and add additional years to your longevity.
Risk management is a very important aspect of retirement planning. Premature death, chronic/long-term illnesses, etc. are all potential risks that need to be addressed and prepared for in case one of these risks were to come to fruition. Strategies such as life and long-term care insurance solutions should be evaluated and considered to ensure any financial damage from a risk coming to fruition is recoverable. The worst thing to happen would be to prepare fully for retirement and be blindsided by an unplanned for risk that strikes a major blow to your finances.
Deciding How Much to Save
After considering the above factors, you will ultimately have to decide how much of your pre- retirement income you will need each year to enjoy the standard of living you desire. Popular estimates usually range from 70 to 90 percent of your current annual income. HOWEVER, all of us are different as it pertains to lifestyle, value system, etc. Thus, these ranges could be much too high for some individuals, creating undue stress during the accumulation years.
Once you have an overall goal and have considered your planning factors, it should be much more feasible to calculate an amount to save each month and each year. It will be important to reassess these factors every two to three years, as your retirement savings will have to change along with your current and expected lifestyle (beyond my constant interaction with my clients, I conduct a formal annual review of their entire financial situation as part of my service delivery commitments). It may help to set up checkpoints throughout your life to make sure you are still on track.
To Leave or Not To Leave a Legacy?
An often overlooked area to explore is your moral obligations to the next generation. Do you have a strong desire and/or need to leave a financial legacy to the next generation? Or, do you feel you have provided sufficiently for your children/grandchildren already? This is a critical and sensitive area to explore but is certainly necessary to ensure proper retirement planning. While a financial planner can provide the analysis as it pertains to the logistics and repercussions of such, it is ultimately your decision as to what direction to take.
As discussed, each of us has a different lifestyle, value system and current (and accumulating) level of wealth. A “one rule fits all” approach is a potentially misleading and a dangerous rule of thumb to promote and follow. Utilizing a CERTIFIED FINANCIAL PLANNER™* is very beneficial in establishing a structured approach to saving for your retirement. Your Planner is your financial “guardian angel,” looking at all aspects of your financial life to ensure a rewarding retirement. After all, having a qualified second set of eyes guiding you to financial success is never a bad thing!