Why Saving Too Much for Retirement Can Be a Big Mistake

It seems like every time you turn on the news, they are talking about how Americans aren't saving enough for retirement. You hear it so much that, if you're like many of us, you start to panic. After all, no one wants to end up destitute in their old age.

While it is true that there is a large group of folks who have no savings, there are also some savers who have saved too much money for retirement. While this might not seem like a bad thing, it can being one of them can lower your quality of life in your earlier years and hinder when you can actually retire.

Here are the two main reasons why you may be saving too much and how to figure out what the right amount is to save. (For related reading, see: 5 Signs You're Spending Too Much in Retirement.) 

Planning Today Is Too General

One big reason you may be saving too much is that retirement planning has become too generalized. With the advent of online calculators and personal finance software, we've found ourselves in a situation where in an effort to make planning easier, tech providers have built too many assumptions into their technology. Not all assumptions work for all people. Everyone has a different life situation that cannot be easily be packaged into a smartphone app or represented by a few numbers that you input to a calculator.

For example, it's unlikely that any automated program will be able to accurately predict how much you need of your pre-retirement income – otherwise known as replacement rate – and what the return rates, inflation and consumption will be throughout your retirement years.

Your replacement rate alone can cause you to save much more than you need for retirement. The general rule is to estimate that you will need 80% of your income in retirement. However, David Blanchett, head of retirement research at Morningstar, found that it depends on your income as well as a few other factors. His research revealed that the real range for your replacement rate is between 54% and 87%. If you are planning for 80% and really only need 55%, that's a big amount of money you end up saving that you probably won't need. (For more, see: Retirement Savings: How Much Is Enough?)

The Housing Factor

Where you live during retirement is one of the biggest costs you will face. How you plan for and manage this aspect of your life will have a big impact on how much you need to save for retirement. "Spending on housing in retirement is extremely difficult to estimate," says Mark Hebner, founder and president of Index Fund Advisors, Inc., in Irvine, Calif. "Most retirees will spend most of their retirement in their own home." If you plan on staying in your home as long as possible, your costs will be lower than if you move to an assisted living facility. This is especially true if your home is paid for and you don't have rent costs.

According to the Bureau of Labor Statistics, the cost of housing ranges from 30% to 37%. If you spend $50,000 a year at 30%, you would reduce your costs by about $15,000. When you spread that out across 30 years in retirement, you'll need to save a lot less money than you had planned. (For related reading, see: Burdening Your Retirement with a Mortgage.)

How to Save the Right Amount

So how do you know if you are saving too much or not enough? The first step is to determine how far from retirement you are. If you are more than 10 years out, it's likely best to save a generic percentage – preferably 15%. That's because the further away from retirement you are, the harder it is to get the numbers exactly right. 

If you are within 10 years of quitting work for good, you can do some more detailed planning that will shape how much you need to save in the years just before you retire. "The easiest starting point is to assume the same standard of living in retirement as in one’s working years," says Hebner. "Chances are, most will not spend that much money since they will no longer have to save for retirement, probably pay less in taxes and also have certain costs like transportation go down significantly." Don't just use the 80% of income as a replacement rate. Calculate out how much you spend now, remove expenses that you will no longer have and add in new expenses that will occur in retirement.

Once you have a real estimate on expenses, you can use that to figure out how much you need to save to be able to pay for those expenses. (For related reading, see: 5 Essential Retirement Savings Accounts.)

Then create plans for medical and living expenses. Since this is the biggest unknown in your budget, knowing your options will help you save the right amount. Research Medicare, long-term care insurance, assisted living costs and in-home care costs. 

Lastly, tally up what you expect to receive from pensions and Social Security. The more you have from these resources, the less you will need to save in retirement accounts.

The Bottom Line

Planning how much you need for retirement is not an easy task. There are many variables, and we typically plan based on generics of these variables. With a little extra time, you can figure out the amount to save that's right for you. And remember that if it ends up that you're saving too much, you can retire sooner – or use some of that money right now. (For further reading, see: Saving for Retirement: The Quest for Success.)