by Michelle Ash, CFP®, CDFA™
As I start to write this article, I feel like maybe I should give readers a caution like you see at the start of some TV shows: “The program you are about to watch contains disturbing images. Viewer discretion advised.” This message is important!!!, but the telling of it isn’t necessarily going to be pretty.
Recently I have had the opportunity to experience a new phenomena in my career. In the past couple of months, much by happenstance, our firm has had a number of younger individuals engage our services. By younger, I mean they are generally of or near my own age demographic: late 30’s to mid-40’s. These individuals have generally been contemplating their future retirement, among other financial goals, and have hired us to put together a retirement plan to see how they’re progressing on that path.
Previously, our firm has primarily worked only with individuals ages 50 and above, who are often in what I call the “final chute” towards reaching retirement.
I have long observed the unpleasant circumstances that loom ahead for individuals who have not planned and saved well for retirement. But since I was usually seeing those individuals at or near the age at which they had hoped to retire, I wasn’t necessarily able to understand what decisions might have led to their current status.
Having the opportunity to work with individuals who are twenty or even more years away from retirement, I can see the habits that cause success, or prevent one from achieving it. In the process of that observation, I am also noticing an extremely disturbing trend.
The issue is this: I notice a general assumption that contributing the maximum funding to one’s 401(k) plan is all that really needs to be done to fund a retirement.
Now, I realize and agree that for some people, getting to the point where they can actually save $15,500 per year of their salary, the current maximum funding allowed for an employee under age 50, is a fabulous goal in and of itself.
But what bothers me is when I see individuals or couples making $150,000 per year, $200,000 per year, sometimes even more than that, and they think that just maxing their 401(k) is all they really need to do in order to be able to retire at age 60, live a long retirement, and have a lifestyle largely commensurate with that they currently live.
I guess I just have one thing to say to these people: WAKE UP. You are living in a fantasy, and if you stay there, the reality you are faced with once you get to retirement is NOT going to be a pleasant one.
Let’s run what I’ll call an “average” desired retirement. It’s a standard many clients describe to me as “comfortable” but is certainly not lavish by most accounts.
• Retire at age 60
• Have $48,000 per year for expenses and budget needs (in today’s dollars)
• Have their house paid off by retirement
• Dollars for Property taxes, homeowner’s insurance, health insurance, and Medicare supplements are extra expenses above the base $48K
• Spend an extra $5,000 per year on travels or other hobbies while healthy
• Upgrade their vehicle every 7 years or so
• Have enough money to cover emergencies, home repairs, and medical emergencies
• Have enough money to last the rest of life no matter how long that lasts
After factoring in inflation, this scenario results in retirement costing approximately $96,000 in year one and $346,000 in the final year (assuming death at the age of 95). Imagine if, just like going out to eat where your waiter hands you a final bill at the end of the meal for all of the different courses you ate, someone were to hand you the bill for your retirement at the very end of it. If someone were to add up year by year the total cost of this retirement, the “number” that would result would be $8,905,800. **(Assumptions are listed below.)
Have you ever seen that commercial where people are walking around carrying their retirement “number”? I have heard many people say they’ve been frightened by the size of some of the numbers. Guess what – unfortunately those numbers can be very real!
Fortunately, there is a potential income source to help offset that need: social security. (As a sidebar, the cynical Gen X’er in me wants to say “yeah right, like we can count on that!) We’ll assume there is no pension income, since a majority of Americans today, particularly younger ones, are no longer eligible for corporate pensions. Using current rules, social security would account for approximately 39% of the overall need mentioned above. **
But that still leaves us over $5 Million dollars of future money needed in retirement that is unaccounted for. This is not, of course – the “number” that needs to be accumulated prior to retirement, since accumulated dollars will likely earn a return during retirement. However, it does accurately reflect the total likely cost of retirement – and can give insight to the size of the number which would need to be accumulated prior to retiring.
Let’s assume our hypothetical family has already saved $100,000 in 401(k)’s, which is the average amount we tend to see amongst individuals around age 40. Solving this equation to determine how much money this family needs to save from this point forward, from age 40 until retirement at age 60, results in needing to fully fund each of their 401(k)’s at $15,500 per year each, PLUS save an additional $1,445 per month, or $17,340 per year.
Is this possible? Especially if this requires them to save a good bit more than the maximum contribution allowed for most employer plans, it requires getting serious about their financial goals – and doing something about them – or… accepting something less. Many people don’t like to hear advice like that, but please understand that it is not a judgment – it is just math.
I realize that at this point, some people reading this article might just want to throw in the towel and give up altogether. As I said earlier, for many people, just getting to the point of contributing the maximum amount to a 401(k) can be a great goal. I do not mean to diminish that accomplishment. Ultimately, any savings you do will be better than nothing. But what I do hope to do is cause people to realize that it takes a lot of hard work and a lot of saving to get to the point of a comfortable retirement.
With that in mind, my general suggestion to people working towards retirement, regardless of age, would be to save, save, and then save a little more. That, or work with a CERTIFIED FINANCIAL PLANNER™ professional who can help you determine what your actual “number” is, and then make sure you’re doing everything you can to achieve it.
- Inflation rate 3.71% based on last 80 years’ historical data. (Source: http://www.emoneyadvisor.com)
- House is assumed to be paid off prior to retirement.
- Property taxes and homeowner’s insurance = $5,000 per year, inflating from today at 3.71%
- Travel/Other Hobbies Budget of $5,000 per year inflates from today at 3.71% and ends at “advanced age” of 82 when many seniors no longer travel or pursue other hobbies as much.
- Car upgrades begin in year 3 of retirement, occur every 7 years, and cost the equivalent of $20,000 today inflated at 3.71%.
- Age at death = 95 for both spouses
- Emergency savings, home repairs, and medical emergencies not accounted for since they are not quantifiable in this fact pattern.
- Social Security income is drawn at age 62 for both spouses.
- Benefit amount = $18,960 per spouse, based on earnings that equal or exceed the current earnings cap of $106,800 throughout both spouses’ entire working history for 38 years (age 22 to 60). (Source: http://www.ssa.gov)
- Inflation rate of 2.5% assumed on social security benefits, since Social Security benefits have not historically kept up with the rate of inflation.
- Both spouses are assumed to live until the age of 95, meaning the family receives both social security incomes throughout retirement.
Additional Savings Needed Assumptions:
- Rate of Return = 7% annually. This 7% is a mathematical figure, is hypothetical, and does not represent the returns of any particular investment or product. Rate of return is applied to both existing accumulated dollars and future invested dollars.
- Starting investment assets accumulated equal $100,000 in 401(k) plans.
- Need reflected ($17,340 per year) is a total additional savings need , above 401(k) contributions of $15,500 per spouse ($31,000 total combined). Total annual savings needed is therefore $48,340.
- Investment time horizon: Age 40 (current age) to age 95 (age at death).
- Assets accumulated are assumed to be fully invested for the full lifespan of our hypothetical couple. Both income and principal are consumed to meet retirement needs.
This blog article does not constitute legal, tax, or personal financial advice. Please consult your own financial professional for personal, specific information.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.