Are You Saving Too Much for Retirement?

Posted by Rick Miller on December 24, 2013

A recent Wall Street Journal article argues that people may be saving too much for retirement. The author spoke to a number of experts and identified several reasons that rules of thumb may be misleadingly high. The key points are important, and all are worth some thought.

• “The financial industry’s typical rule of thumb—which states that retirees need to save enough to be able to replace 75% to 85% of their preretirement income every year after they stop working—isn’t really useful for many people.” This is true: there are several fundamental problems with this rule.
  • First, as the article states, many of your pre-retirement expenses won’t continue afterwards. Most significantly, you won’t be saving for retirement after retirement. You most likely won’t be paying a mortgage either.
  • People can rely on other resources besides their savings, and these resources vary. For some, Social Security and a defined benefit pension will replace a high percentage of their pre-retirement income. They’ll need to save less than average. Others may need to save more.
  • The composition of people’s spending also varies. For example, some people have relatively little time to devote to cooking during the years they are working. They will spend a lot on restaurant meals and prepared foods. Once they retire, they’ll buy more groceries and cook more for themselves. Such people can save less.
• New analysis by David Blanchett of Morningstar suggests that the “4% rule” that many financial planners apply (draw 4% from your portfolio the first year, then increase the dollar amount every year at the inflation rate) is too conservative. The original 4% rule assumed that people would live 30 years in retirement and spend the same amount every year (accounting for inflation). However, according to Blanchett, many couples can draw start drawing more than 4% because
  • Some couples won’t survive 30 years in retirement; and
  • Some couples spend less the longer they are retired, and therefore draw successively less from their portfolios each year they are retired.

It is true that many couples will not live to 95 or 100. However, those that do will be sorely disappointed if they run out of money. And it’s not clear whether those whose spending declines throughout retirement are happy spending less or whether declining resources dictate economy measures.

• Some people plan dramatic lifestyle changes post-retirement. For example, if you plan to embark on ambitious and expensive foreign travel after you retire, you may need to save more.
• You may wish to save extra to protect against expensive surprises such as uninsured long-term care expenses or to allow you to respond to unexpected family needs.
• Changing where you live in retirement can also have an impact, especially if you move between states with dramatically different income tax rates or costs of living.

Rules of thumb may work for average people, but I doubt that you are average. Your situation is unique. Your retirement plan should incorporate every important aspect of your life: your family, your health, your interests and your dreams. No rule of thumb can do that.