And you’re not saving for retirement(!)
My 6 line spreadsheet didn’t hold a candle to my financial advisor’s multi-tab monte-carlo-simulated analysis of where I was.
He could account for travel at the front of our retirement and medical expenses at the end of our retirement and modeled just when it was most efficient to start taking Social Security.
You’re going to (hopefully) retire once. A good financial advisor has seen thousands of people retire and probably has a perspective on some gotchas. (Ours knew how to handle the specifics with a State pension.)
Just a passerby, wondering why this is in GD instead of IMHO.
I can’t emphasize enough the need to account for inflation. I was lucky enough to retire, 10 years ago, with a pension equal to a little over half of my highest salary. That pension is now worth about 25% less than when I retired (although it helps that I’m paying the same mortgage amount now as then, except for insurance and taxes). I don’t know what a person can do about that, except not depend too much on a fixed income.
On the expenses line, I would include increased cost of upkeep for anyone who owns a home (because as you get older, there is less you can do for yourself, and things continue to break down). In fact, I wouldn’t count a home that you own as an asset, because you won’t get any benefit from it unless you sell it – and if you’re like us, rental costs have zoomed past our monthly mortgage, so selling it means using a large part of the equity just to keep a place to live. A home is an expense under any circumstances.
One other general point I would emphasize in any class about retirement planning, especially for young people: you can’t plan perfectly. There are just too many unpredictable elements. My advice to students would be to do the best you can, then put it aside and get on with your life. Pay attention to changes in laws that affect retirement; maybe tweak the plan every five years if things have gone differently than you expected.
Basing your needed retirement income based on income at middle age doesn’t always make sense. At age 45 you will have a mortgage, you may have student loans, and you will have money you have to spend on your children. You’ll be putting money into retirement accounts and your tax rates will be higher. By your 60s hopefully all those expenses will be gone and your tax rate will be lower.
There is also the fact that many people downsize in retirement. Moving from 3-5 bedroom houses down to 2 bedroom houses is not uncommon. Also some people leave HCOL areas and move to more MCOL and LCOL areas.
A couple that needs $15,000 a month in gross income living in a high cost of living city with 2 kids in college, money to put into retirement accounts and a mortgage may only need $4,000 a month in gross income to live in a paid off home in a medium cost of living area and kids who are independent.
Then you have the fact that the tax structure in retirement is different. You generally don’t pay FICA taxes when you’re elderly. Income from a post-tax IRA is tax free. Long term capital gains and qualified dividends aren’t taxed or they are taxed at 15% for most retirees. Your total tax rate (federal, state and local) may be 30% of gross income when you’re middle aged, it may only be 10-15% of gross income in retirement.
If you just want an easy answer, tell them this
“80% of your regular income is needed in retirement income. Invest early, invest consistently, and invest in index funds”
Yes. Even with no reforms, social security will remain solvent, it’ll just reduce benefits by ~20%. There have been repeated reforms to the tax rates and benefits to both social security and medicare in the past, it’ll probably happen in the future too.
I think it’s difficult to give a precise % of salary.
Here’s my situation:
- I own my house (so no rent)
- I have no debt (e.g. credit card paid off)
- I have an Individual savings account - Wikipedia worth thousands of pounds (which after several years is now tax-free)
- I have two private pensions (both (Defined benefit pension plan - Wikipedia), plus the UK State pension
I estimate that lot adds up about 60% of my salary (but I was well-paid as a teacher at a private school.
The place to start is the “three legged stool” metaphor which used to be a common way to talk about living in retirement.
Social Security + Pension + Individual Savings (the pension has been mostly replaced by a 401K or similar program)
Once they understand that Social Security - even if it is forever fully funded - is not designed to be a retiree’s sole support, they may be more ready to accept the rest of your course.
As for how much money they need, the most attainable number I’ve ever heard is 2/3 of your income at the time you retire. But the more important message they need to grasp is, retirement mean somewhat lower living expenses, but a huge drop in income. How do they prepare for it.
Until you can’t do them any more. I used to be pretty handy. I once did some pretty significant home renovations. Now I dare not risk getting up on a ladder. I dare not risk shoveling snow. I can’t mow the lawn, especially in hot weather, without risk of heat exhaustion. You have to account for the fact that you eventually have to pay either youngsters or professional services to do all this stuff for you. Life is cheaper in some ways in retirement (no need to buy fancy clothes, no need to commute, minimal wear & tear on the car) but more expensive in other ways.
I’m not sure why you are calculating Social Security benefits that way. Social security takes 35 years of earnings. If there are more, it takes the top 35 years. So while it is more complicated, it would be better to have them plot expected raises and then use that to calculate the benefit.
The way I did it was to analyze my spending before I retired, adjusted for things I would cut down on (gas for the commute) and things I might do more of, like travel. Someone mentioned the drop off in travel as you age, I can assure you that this is real. However they also need a reserve for repairs, new cars, etc.
One way of encouraging savings is to tell them about income generation from the retirement account, which goes on top of Social Security. The more they make every year from the investments the less they have to take out. I have more money now than when I retired 9 years ago, but not everyone is going to have such a cushion. It is more likely if you start early and don’t touch the retirement account. I suspect you tell them that already, but you can produce some alarming examples of what happens if you don’t.
The biggest thing I learned after I retired is that your situation depends less on the balance of your account and more on cash flow. If Social Security plus some of your investment income is greater than your expenses you can laugh at the market. It is a very different mind set from looking for growth investments before you retire.
None of this discussion is wrong, but most of it is unhelpful for retirement planning, beyond scaring people into saving far more than they do. Comments focussing on expenses are closest to being useful.
Comments focussing on percentages of prior income are close to useless, since they ignore that the more you earn the more you can save. (And, obviously, the smaller your pension needs to be as a percentage of previous earnings).
In the developed liberal western democracies we are going through an unprecedented period where a large proportion (though still less than, say, half) of elderly people are enjoying long affluent retirements. This has happened for a number of diverse reasons (which vary from place to place) which have transfered an exceptional share of wealth to this lucky generation. This has given current workers entirely unrealistic expectations of what they can expect.
Let’s do some sums. Let’s ignore inflation and interest, to make it easier but also because they should be a wash. (If you’re thinking ‘but what about the opportunity to earn interest above the rate of inflation’ then hold that thought. It will make the following numbers less horrific, though remember, the current rich retirees are enjoying their retirements because they enjoyed unexpectedly favourable investment returns, which to some extent represent a transfer of wealth from current workers to them. Current savers have actually lost that money, and have little scope to steal (sorry, earn) similar returns from the following generation. And, of course, to match that wealth they have to earn twice as much - first to replace the wealth they transfered and then to get the same advantage.)
Let’s assume you want to retire for 15 years ( say retire at 72 and die at 87) and that you can live a frugal life on 40,000 local currency units a year (whether £, € or $). That’s 600k you need to have saved at retirement.
Want to retire at 60 and have 60k a year? Even if you persuade yourself you’ll die by 80 that’s 1.2m.
Both these scenarios are after tax. Let’s say in the first scenario the pensioner is poor and so only needs 700k pre tax. In the second, a bit more tax, so say 1.5m.
Let’s say you start saving in earnest at age 25. 700k at 72 needs you to save about 15k a year. 1.5m at 60 needs about 43k to be saved every year from age 25.
These savings rates are after paying for housing. Yes, (some of) the current generation of retirees made huge profits through house price rises. The current generation of workers are paying for this - they don’t get the same benefit unless the following generation transfers twice as much. This is not going to happen. Again, all of the pressure on investment returns suggest the current saving generation is going to get much poorer investment returns than the current golden generation of retirees.
So where does this leave us? €40k a year is actually a very good pension in Europe, so if you have been saving €1,000 a month (but not counting ‘investment’ in housing) since you were 25 you can hope for some sort of retirement.
If you’re saving 5k a month, then you can expect a good retirement, even if you only start saving in earnest when you are 40.
So, the question is, how many 25 year olds do you know who are saving 1,000 a month? How many 40 year olds saving 5,000 a month? In either case, what is that as a percentage of their salary? Most of the 40 year olds I have ever known didn’t even earn 5k a month, saving that much would be a fantasy.
It might be different in America. I can barely conceive how anyone can pay $100,000 for a car.
These numbers are so rough as to be almost worthless. But they do give an idea of the scale of the problem. You can make your own numbers up if you want to. Hopefully, I’ve at least shown how easy it is to do rough numbers.
Conclusion: very few people are saving enough money for sophisticated financial planning to be worthwhile. For most people, the only advice they need is don’t take on any debts apart from a mortgage, and save as much as you possibly can as well. Remember, most financial advice is realy just tax planning advice. Very little adresses ‘how much should I save’ since in almost all cases the answer is simply ‘as much as you can’. Or even more pithily, just ‘more’.
Important disclaimer: I am not your personal financial advisor and this is not formal financial advice. If you require personal financial advice you should consult a professional advisor who is licenced to practice in your jurisdiction.
As someone who’s retired, has no mortgage, but has 2 houses with associated expenses (1 is a holiday house, not rented out), and considering the taxation on Super is different to income when you’re working, I’m working currently on 50% of my salary in super, plus the centrelink (social security) I get for being a carer for my mother.
The last salary I earned was $110kpa, but I was winding into retirement then so took less to work part time.
At the moment I’m spending around $65-70kpa but that includes materials for home renovations and holidays.
If I had just one home, wasn’t spending money on renovations and was happy to sit on my porch whittling, I’d need a lot less.
‘Super’?
Kpa?
What do these terms mean?
“Super” is the Aussie rough equivalent to a 401k.
“kpa” means “thousands per annum” and is a standard term in accounting, though more in UK / UK-related countries than US practice.
Your post apparently assumes a zero rate of return on savings. That makes the whole thing nonsense.
The amount you need to divert from current income into retirement assets over the course of your life is far, far less than the amount of assets you need at the start of retirement. Provided you start early and achieve a reasonable rate of return.
I noticed the same thing. Also that retirement savings do not provide any return, but apparently are stuffed under a mattress. $1.2 million can offer a very decent amount of income a year, which, when added to Social Security or another pension, would let it last long after 80.
I wasn’t saving $5,000 a month even as I approached retirement and had reduced expenses - yet wound up with more than $1.2 million.
There is also an assumption here that the market is at a forever high. People thought that 40 years ago also. Glad I didn’t listen to them.
Not having debt is good advice, however. Also not buying $100 K cars.
I was really trying to figure out what kilopascals had to do with anything.
Okay, but, curious minds are still wondering what the ‘k’, in ‘kpa’ actually stands for? Why isn’t it a ‘t’ if it’s for thousands?
Pretty sure it’s “kilo”
K is the standard abbreviation for thousand.
$100k = 100 thousand dollars
10km = 10 thousand metres
kpa = thousand per annum
Thanks, I am aware of K = 1000 in many things, but I’ve never seen this abbreviation before, with ‘pa’ stuck on the end! Was thinking it was a currency I was unaware of, ha!
I’m not following your whole "stealing / wealth transfer logic, unless it’s some sort of hyperbole.
You can’t ignore interest or inflation because it usually isn’t a wash.. You generally want to be parking your money somewhere where it’s earning greater returns than inflation, otherwise you are losing money over time.
Investment returns don’t represent a “transfer of wealth from current workers.”
The American Social Security System is very much literally a transfer of wealth. Payments come out of current workers paychecks to fund current retirees.
In theory I could go out tomorrow and pay $100k for a car. I could probably even afford it. But there is a ton of other things I’d rather do with that money (saving for my kid’s education, paying off the mortgage, putting it away until retirement, just having extra cash in case of emergencies). So I’m content to drive around in my reliable 15 year old hand-me-down Ford Taurus. But I digress.
As for the OP’s exercise:
I know there are some rules of thumb financial planners use. Like you need X times your annual expenses or plan to take no more than 4% of your accumulated savings each year.
A more granular method might be to budget out your expected expenses. Assume they will increase by some average CPI each year from 65 to whenever some actuarial table says they will die (plus a few more years for good measure).
One thing that would be great to impress upon kids is the power of saving early. Make sure they understand the massive growth that comes from compound interest when you start saving early.
This lesson is just as important as understanding their retirement savings target. If they start saving early, their retirement savings can be many multiples greater than if they start later.