Retirement: You Can't Save Too Much, But How Much is Enough?

Retirement savings and the lack of retirement readiness among many Americans is very much in the news these days. You can approach saving for retirement and the degree of readiness in any number of ways, but a very central question is, how much is enough for a comfortable retirement? As with many aspects of financial planning there is no one right answer on this topic. (For more, see: What is the Size of the Average Retirement Nest Egg?)

This is a complex issue and the right answer will vary from person to person, situation to situation. Pre-retirees are well-advised to seek out and engage the services of a qualified fee-only financial advisor to help them answer this question and plot a financial course through retirement.

Factors to Consider

The first step in is to determine your desired retirement lifestyle and the price tag to maintain that lifestyle. This means putting together a retirement budget. Based upon Fidelity Investment's Retirement Health Care Cost Estimate latest study a couple both aged 65 at retirement can expect to pay $245,000 for healthcare costs in retirement, up from $220,000 just a year ago. Clearly healthcare costs need to be a consideration in preparing this budget. (For more, see: How Soon Should I Start Saving for Retirement?)

The client’s total financial resources for retirement need to be considered and compared to the budget. Resources might include retirement accounts, taxable investments, pensions and Social Security, and any other sources of funds that can be used to fund their retirement.

A qualified financial advisor can help their clients determine what type of lifestyle their resources will support and if there is a gap between what they’ve accumulated (and what they are on track to accumulate) and what they need to support their desired retirement lifestyle. (For more, see: How Advisors Can Manage Evolving Retirement.)

Estimates Vary

The Employee Benefit Research Institute 2015 Retirement Confidence survey revealed varying opinions by workers as to what they felt they would need to accumulate in order to enjoy a comfortable retirement.

  • 11% felt they needed to accumulate $1.5 million of more by the time they retire.
  • 10% felt they needed to have between $1 million to 1.5 million accumulated.
  • 25% pegged that number in the range of $500,000 to $1 million.
  • 19% thought $250,000 to $499,999 would suffice.
  • 25% felt the number would be $250,000 or less
  • 8% didn’t know

This shows not only differences in worker’s situations but also a wide variance in their knowledge about how much income it actually takes to maintain their preferred lifestyle during retirement.

At one point $1 million was considered a solid amount for a retirement nest egg. But with longer life expectancies, concerns about the future of Social Security and rising healthcare costs in retirement, $1 million may not be adequate for many retirees.

As of a few years ago, the Legg Mason Global Asset Management's Global Investment Survey pegged the number needed at $2.5 million.

Fidelity estimates that retirees need about eight times their ending salary to fund a retirement for 25 years.

A popular rule of thumb looks at income replacement ratios based upon the level of retirement income as a percentage of a worker’s working salary. For example, an 80% income replacement ratio would indicate that for someone earning $100,000 per year during their working years they would need $80,000 per year to replace 80% of their pre-retirement income and conceivably maintain the same standard of living in retirement.

The 4% Rule 

The 4% rule says that a retiree can safely withdraw 4% of their nest egg during retirement and assume that their money will last 30 years. This very useful rule of thumb was developed by fee-only financial planner Bill Bengen. Like any rule of thumb it is just that, an estimating tool. Do not depend on this rule; I suggest a comprehensive financial plan done by a competent fee-only financial advisor that will examine all of the components of your unique situation. However the 4% rule is useful as a quick estimating tool.  (For more, see: 10 Ways to Save Your Retirement if You Didn't Save.)

Getting to the Number

Keeping in mind that the 4% rule is only a good “back of the napkin” estimating tool let’s see how a married couple with a $1 million combined in their 401(k)s and IRAs can achieve $100,000 in gross income in retirement.

Assuming they stick to withdrawing 4% from these accounts this would generate $40,000 in gross income annually. This leaves another $60,000 needed from other sources. As mentioned above, all of the client’s financial resources available in retirement need to be considered. In my experience every situation is unique and should be treated as such. 

Most clients will have Social Security, some will have a pension. They may have retirement accounts such as an IRA, a 401(k), 403(b) or similar. There may be taxable investments or a Health Savings Account that can be tapped tax-free to cover medical costs in retirement. (For more, see: Pros and Cons of a Health Savings Account.)

In this case let’s assume that the clients will receive a combined $40,000 from Social Security. This brings their gross retirement income to $80,000, leaving a $20,000 shortfall.

How can they close the $20,000 gap between their desired income and their resources?  Here are some options:

  • Do they have assets outside of their retirement accounts that can be tapped?
  • Do they have funds in an HSA account that can be used to cover medical expenses in retirement?
  • Do they have stock options or restricted stock units from their employers that can be cashed?
  • What can they do to reduce expenses such as downsizing their home? Ultimately do they need to reduce their desired retirement lifestyle?
  • Can retirement be delayed for a few years?  This could allow the couple to accumulate a bit more for retirement and it also delays the need to tap into their retirement accounts and builds up their Social Security benefit a bit longer assuming they delay filing until they stop working.
  • Is it feasible for one or both of them to work full or part-time during the early years of retirement?  The concept of a phased retirement is gaining in popularity with many employers.

This is where a financial advisor who specializes in working with retirees and those approaching retirement can help. They are used to helping people plan their retirement finances and they are also adept at ensuring that all options and assets are considered as part of the equation.

The Bottom Line

A qualified financial advisor can help those approaching retirement and those earlier in their careers to hone in on a target retirement goal based upon their unique situation. (For more, see: It's Never Too Early to Start Saving.)