How much do we need to save for retirement? This is the question most people ask and desire a specific numerical answer for planning. However, the number of assumptions in these analyses are too many and too variable to give a specific answer. What we do know is most households are saving too little and spending too much (see first graph). With the elimination of most defined benefit pension plans, most retirees will be relying on Social Security benefits and 401(k) plan savings. Social Security benefits may be reduced based on current projections of the future of the fund. Also, as we are experiencing now, inflation and investment outcomes in tandem impact purchasing power of future retirement plan savings. Is it time to look at your situation and to make changes to impact your future?
Please continue to The Details for a retirement example.
“There’s one thing I always wanted to do before I quit…retire!”
This is the question most people ask when approaching retirement age. You may have seen ads on television asking people what their “number” is, or how much they need to retire and maintain their desired lifestyle. The amount necessary is an estimate based upon a number of unknown factors. These factors include assumptions most people have not even considered. When determining required savings, many people use “rules of thumb” or simple straight-line assumptions. However, the variability of any of these assumptions could significantly change the results.
First of all, how much do you currently have saved? Unfortunately, most people fall far short of what will be needed. In fact, almost 25% of workers have no retirement savings at all. According to a study by PwC, one of the largest international accounting firms, the median (not average) savings for those between ages 55 and 64 equals $120,000. For those ages 45 to 55 it drops to $82,600. See the chart below.
In a study by the Federal Reserve, only about 21% of people have defined benefit pension plans. Most companies today utilize defined contribution plans such as a 401(k) plan. Defined contribution plans put the onus on the employee to agree to sock away part of their paycheck. The employees are also in control of how their funds are invested. Most employees tend to save far less than they should to achieve their retirement goals. The Fed study stated, “One-fourth of non-retirees indicated that they have no retirement savings, and fewer than 4 in 10 non-retirees felt that their retirement savings are on track.”
One of the first assumptions to establish is at what age you plan to retire. In order to receive full Social Security (SS) benefits, those born in 1960 or later will have to retire at age 67 or later. Retirement between ages 62 and 67 will result in a reduced benefit amount. Most people believe they can control when they retire; however, the Fed study also stated “Collectively, health problems, caring for family, and forced retirements contributed to the timing of retirement for 47 percent of retirees.” So, oftentimes your retirement start date is not under your control.
Social Security was never intended to be the sole or main provider of one’s retirement benefits. Unfortunately for many, the lack of other savings forces SS to be their predominant income in retirement. A recent analysis indicated that the Social Security trust fund would be depleted by the year 2034. At that point, benefits will be paid based upon SS taxes collected. Without further government subsidies, SS benefits will need to be reduced to 77% of their current level.
How much savings would be needed in addition to SS? Let’s look at a simplified example. A couple, both age 52 want to retire at age 67. Assuming they would like an income of $100,000 in today’s dollars at age 67, how much would they need? Let’s assume their combined SS benefits at age 67 equals $85,000.
First, the retirement income desired needs to be estimated based upon the assumed inflation rate. Over the past decade inflation was extremely low, therefore the impact was not as top of mind as it is today. With inflation running over 8% annually, suddenly it has an extreme impact. Let’s assume that over the next 15 years inflation averages 4% annually. This presumes a significant reduction from today’s level. The $100,000 in desired income would turn into a need of $180,000 after factoring in 4% inflation. Subtracting the SS benefit of $85,000 per year, the couple would need another $95,000 annually to meet their goal.
How much savings at age 67 would be required to pay $95,000 per year? Unfortunately, it isn’t that simple. Does the couple want to leave a legacy for children or charity, or do they want to spend everything they have saved? What if they live longer than planned? Will health care costs continue to skyrocket every year, and if so, will this impact their income need? How much will the couple earn on their savings both between now and retirement in 15 years, as well as during retirement?
For this example, assume at least one of the two in the household lives to age 95 and inflation averages 4% between now and age 95. Keep in mind the inflation assumption could prove too low if the Federal government continues to use Federal Reserve funded deficits to solve all future crises. So, after deducting the expected full SS benefits, the amount needed in a lump sum to provide the income needed, with none leftover after age 95, would be approximately $2.7 million. Now, if SS benefits are reduced to 77% of expected benefits, then the amount needed would be higher. Also, this basic example is only assuming a 4% annual return on assets, sufficient to keep up with inflation, but does not consider the impact of income taxes. If a higher rate of return was achieved, a lower amount would be needed at retirement.
With the average amount saved of $82,600 for this age group, or $165,000 for an average couple, it is easy to see why there is concern of a retirement crisis. However, let’s assume for this example the couple is above average in their savings. What other concerns exist? The fact that the current stock market remains considerably overvalued, and the economy is facing recession imposes risks on future asset returns. The graph below from economist John Hussman illustrates that based upon historical results and current valuations, the average annual return over the next 12 years for a balanced portfolio (60% stocks, 30% Treasury bonds, 10% T-bills) is expected to average less than 2% annually.
Because of extreme equity valuations combined with a weak economic outlook, the expectation for future returns on a balanced portfolio fall below the potential future inflation rate. If that were to occur, a household would need to either save more before retirement or expect to spend less. As the study cited above shows, working longer may not be an option for everyone. Health, family circumstances and job opportunities all will be considerations for how long one can work.
The future holds many uncertainties. The status of Social Security benefits, the level of inflation, income tax rates, economic growth and job opportunities, as well as stock and bond market performance. To understand how much will be needed at retirement, it is important to factor all of these into consideration based upon the current picture. Then, as circumstances change, assumptions and projections will also need to change. In this environment, there is not one specific “number.”
The S&P 500 Index closed at 3,771, down 3.3% for the week. The yield on the 10-year Treasury Note rose to 4.16%. Oil prices climbed to $93 per barrel, and the national average price of gasoline according to AAA increased to $3.80 per gallon.
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© 2021. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.
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