Got Enough To Retire? Frugal Spenders Just Might

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In a CNN Money article titled “Got enough to retire? Think again”, I actually found the opposite.

The main point of the article is that you may need to replace a lot more than just 70-80% of your pre-retirement income after you stop working.
Here’s the chart of average replacement rates from an Aon study:

However, I am agreeing with the authors of Spend Til The End on this one – using replacement rates and averages for this sort of thing is dangerous. One should always look at their own unique situation. It’s you, isn’t it? For example, I don’t see why a household earning $100k or even $500k a year can’t get by on spending $40k per year, especially if their mortgage is paid off.

But after looking at the chart some more, something else caught my eye.

Let’s just say that your spending in retirement requires income of $40,000 per year. This is the same as assumed for a household earning $50,000 pre-retirement according to the study. Even though we earn more than that, I know that we can easily run on $40k per year outside of housing costs.

The graphic suggest that 50% of that, or $25,000 per year, will be covered by Social Security. That only leaves $15,000 per year to be covered by your pension or investment portfolio. Assuming no pension and a 4% withdrawal rate, that means you would need a nest egg of $375,000 in today’s dollars. That is much less than the multi-million dollar figures usually being thrown around.

Now, how much would you need to save to get that $375k? If you save $5,000 inflation-adjusted dollars per year, and they earn a 4% annual real (above inflation) return, every year for 35 years – you’d end up with a little over $380,000. In essence, you’d just have to max out your Roth IRA each year and call it a day. (The contribution limit is $5,000 this year, but the cap rises with inflation.)

Of course, this is all rough numbers and you’ll still have to work until the full Social Security retirement age. Most young people like myself are skeptical of Social Security, but I have come to believe that SS will be with us for a long time – it is just too critical a piece of the retirement puzzle for much of America. And hey, the solution to any underfunding – as always – is simple: tax the high-income earners more!

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Comments

  1. This also assumes that Social Security is really still there when you retire.

  2. I think the chart confuses income and expenses, or they assume the both are identical.

    It strikes me unlikely that post retirement, folks who earned $250k in net income pre-retirement need to replace it with 90% of that #, instead I think they rather need to replace 90% of their pre-ret expenses which SHOULD be a fraction of their former income.

    Then again, in today’s spend-it-while-its-hot culture, maybe most folks do have incomes that equal or don’t even each their expenses.

    One reason why high income folks may need to replace more is because they tend to have jobs that pay for their health insurance while lower income folks have to pay a large portion or all of that cost themselves. So retiring is relatively more expensive for those who have to pay for health insurance on their own all of a sudden.

  3. I always laugh when I see these retirement calculators based off of current income. I realize that I’m in the minority here, but I don’t let my income change my spending habits (I’ve maintained approximately the same comfortable standard of living since that I had in college, even though I graduated 3 years ago and make 100x more money). A more appropriate rule for me would be derived from current spending habits.

    You didn’t mention health care in your post. What does your crystal ball tell you about the future costs of health care?

  4. One thing however is that your income from Social Security is not based upon a flat, $20-25 thousand per year. If you calculate out the percentages the income levels vary based upon how much you earned pre-retirment. See here “Under current law, if you have average earnings, your Social Security retirement benefits will replace about 40 percent of your pre-retirement earnings. The percentage is lower for people in the upper income brackets and higher for people with low incomes.”, from: http://www.socialsecurity.gov/planners/morecalculators.htm

  5. I agree it appears most retirement articles claim that what you are saving is never enough, and I agree that everyone’s situation is different. For us, however, like the poster above, we are concerned about health care costs and anticipate due to our current health situations that our costs will be very high in retirement. This is why we are saving as much as we can afford for retirement right now. Though according to these calculators it still isn’t enough!

  6. I’m with Baughman, like him I’ve kept my spending pretty much in line with when I left college. People don’t like me come bonus or tax refund time as I don’t let that raise my spending caps a penny and so I can only shrug at them when asked what I’m going to do with the extra infusion. Same thing with raises since it occurs months after when I’ve already figured out what my monthly caps are.

    I believe we’ll have some sort of UHC. Right now health care is making the US uncompetitive vs the rest of the world that do have UHC. This might suck for those in the health care industry and the rich.

  7. Here’s a good article from Fortune outlining future costs and likely future tax policies and how to save for them. It also discusses health care costs some.

    http://is.gd/5eB9

  8. I’m with you and Scott Burns – these retirement income replacement rates that are echoed around by so-called experts are – to steal a phrase – rules of “dumb.” You need to focus on expenses, not income, when considering your retirement needs. The high replacement rates published by those who sell investing products and services are used as marketing tactics – to get you to do and spend more, including taking more riske.

  9. You seriously think you could run on $40k if you were 40 or older? Until you hit 55, medical insurance is going to eat up a huge chunk of that if you aren’t in your 20s or 30s. We’re also setting ourselves up for monster inflation, since it seems we’ve likely avoided a deep depression. With an economic landscape like we have, there’s really only two choices, take the hit with a depression or monster inflate your money. It’s looking like we took the latter choice (which is the better choice for most people, since it means there will still be jobs, just sucks if you have savings).

  10. I like that, rules of “dumb”. I personally am not planning on any social security help, I think it will still be around in some way shape or form, but I’m not counting on it. I’d rather err on the side of caution then find myself 90, too old to work and out of money. A lot of it depends on your retirement plans as well, do you want to sit home and watch oprah every day or will you be off galavanting around the globe. Some retirements are cheap, others not so much.

  11. There’s only two things I really want in my retirement — most of my loved ones living nearby (I know I won’t have all them unfortunately), and my health. I could easily go to local beaches, parks, swimming, cycling , libraries, malls, restaurants and/or stay home and cook and watch TV and read. Maybe take or audit (for free) some classes at a local college. I wish I could do that now. Some fun things require money – but luckily for me, not too much money. I love where I live, it’s beautiful and totally convenient. I like galavanting in my own neighborhood.

  12. Never understood these “How much will you need a month in retirement?” studies. If you’re close to retirement, just add up what your actual expenses will be (it can’t really be that hard, can it?). If you’re far from retirement, what does it matter if you know you need to replace 75% or 85%, the other variables like inflation and rate of return on your investments make it impossible to calculate your success that precisely anyway.

  13. Susannah – No, *early* retirement will cost a lot more. As I stated, this assumes you’ll work until full Social Security retirement age, at which time you are also eligible for Medicare.

    The current health care system is unsustainable. Over the next decade, things must be changed, so I’m taking a wait-and-see approach to see how it shakes out.

  14. auntie_green says

    one thing I don’t hear many people mention in regards to these retirement/income projections is, how does housing costs fit in? I’m in my early 40s, and intend to have my house paid off within 10 years (unless of course, I move, which I have no plans to right now, but who knows?) A lot of firends/acquantances either rent or have no intention of paying off their mortgage (or think mortgages are a good thing because they get a tax deduction. yikes!)
    Obviously, if you have no mortgage, your expenses could be much lower…..Do these charts assume you have no mortgage/only property taxes and insurance? Or do they assume you have a mortgage? Or are they all different?

  15. Our current health care system is not only unsustainable, it is already inadequate. And in view of the Wall Street meltdown, we had better figure out a way to make Social Security work far into the future. Those who will be able to save enough to retire entirely on their own will be a tiny minority. Contrary to financial industry propaganda, we can not all be millionaires. Both Republicans and Democrats will have to wake up this reality sooner or later.

    By the way, any statistics on how many fewer millionaires we have now as opposed to three months ago?

  16. this chart is for two workers which means one worker will receive 25%
    or less. Remember Medicare premiums are taken out of your social security paycheck.

    Also one of the workers in the chart is 65 and the other 62 so one worker is penalized for taking Social Security early.

    I retired at 59 and took Social Security early. I’ve replaced over 100 per cent of my last salary but I don’t have a mortgage and I have rental income on houses I either paid for or am going to own outright.

    Biggest issue of all is whether or not you have a defined benefit pension as there are so few left. Companies took advantage of shifting the retirement burden over to employees with 401k plans and we see what they did now. Left workers holding the bag so big executives can be protected with bonus and perks the U.S. taxpayer is paying. So unfair.

    Makes the mortgage crisis seem faint compared to this scam.

  17. I very much do NOT believe you should count on Social Security in your retirement plans. The current system is unsustainable, simply because people are living longer, and there will soon be more people collecting benefits than there are paying them in.

    No amount of political games will be able to overcome simple math. Plan for social security benefits to change dramatically. Better yet, don’t count on them at all. You’ll be happier when you retire!

  18. The key point correctly made by this post is the advantage frugal spenders have over spendthrifts when saving for retirement. The Rule of 25 shows that for every $1,000 per month less in spending required for eternal bliss you reduce your retirement savings needs by $300,000 (25*(1,000*12 months)) – and that is after clearing the Social Security threshold as shown above. The mistake most people make when planning retirement is thinking in terms of assets saved rather than the cash flow they produce. The cash flow is what is important due to growing longevity issues and other reasons to complicated to explain in this brief comment.

    Hope that helps…

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