How much money do you need for retirement?
It’s a simple question, and my answer is straightforward: More than most people realize or want to believe.
I think that leads to a few more questions:
Will My 401(k) be Enough for Retirement?
It’s interesting, when you think consider the question. First of all, do we all want to put our eggs into one basket? Asset allocation should employ diversification, and most 401(k) participants are focusing on equities. It’s best to truly take a holistic view of your financial needs, timing of such needs, and risk preferences when deciding how to make your investments.
Many people think that regularly investing in 401(k) means that they should be on their way to a comfortable retirement. Not necessarily, and it’s vital that everyone at least considers this. After all, is investing in a 401(k) – even going to the point of maxing it out – going to provide enough money to maintain a lifestyle you’re happy with in retirement?
Think about it. The maximum annual contribution is $16,500 per year. This is actually a figure that is quite difficult for many people to achieve, and is not typical of how much most people actually contribute to their 401(k). That said, how far can that $16,500 really go?
If I look at my expenses, $16,500 as it is will pay for multiple months of living, but certainly couldn’t pay for annual living expenses at my current lifestyle – which seems to be fairly reasonable as it is. Now, it seems to be very easy to say “Oh, we’ll just downsize when we’re older”, but when the time comes, will you really be able to do that? Think about it, and consider your own sense of wants and needs, discipline, etc. Additionally, think about the reality that you’ll have increased health care costs. Besides, who wants retirement to be a step down in lifestyle?
If one obtains a rate of return on investment that far exceeds inflation, and does this over an extended period of time, it might change the equation a bit.
Let’s say someone is in the minority of people that is able to contribute the $16,500 limit to a 401(K) (not considering the $5,500 catch up option for those over 50). Let’s also assume the following:
Holding Period of Investment: 20 years
Rate of Return: 10%
Inflation Rate: 3%
Tax Rate: 30%
After 20 years, this person will have total of just over $111,000 – just from that one year’s investment that has compounded. Great, right? But, we have to pay taxes on this money when withdrawn, right? Let’s assume a 30% tax upon withdrawal – this now gives us about $77,700 after taxes.
Still pretty good, right? Well, once we factor in the time value of money (since a dollar today is worth more than a dollar tomorrow), the value in today’s purchasing power is just over $43,000.
Thus, in the scenario above, with those assumptions, saving the max $16,500 would lead to around $43,000 in 20 years based on equivalent purchasing power. That’s how much one year of savings would give you in annual expenses, if you looked at it a year for year basis: one year of work = one year of retirement.
That may or may not be enough for you to happily live on during one year of retirement. But consider the following factors:
- How much income was required to save that $16,500? Not everyone can or does prioritize savings, so for many folks it would take a relatively substantial income to make that.
- This assumes a 10% annual rate of return. What if that rate of return is much less?
- What if it’s something along the lines of, let’s say, 7%? At 7%, The $43,000 value (in today’s purchasing power) goes down to about $24,750.
- If it’s even lower – say 5%, the same calculation brings the value down to just under $17,000. Just how far would THAT take us in one year?
The point is not to discourage anybody from investing in a 401(k). They’re great investment vehicles, and are a really good way to take advantage of tax-deferred growth. Plus, they’re an excellent way to encourage automatic savings. I’m a fan.
However, just putting away some money in a 401(k), even maxing it out, might not be enough to live the retirement you want to have. Consider the examples above, and run your own numbers factoring in taxes, realistic rate of return and time value of money (inflation). See what you think.
My takeaway: to be able to retire at the lifestyle level even close to what you’re having now, go beyond the conventional “wisdom” of deducting only 10% of income and considering it done. When you run the numbers, for many of us, we need to save more. Think about how to do that, with a combination of efforts. This leads us to the next question:
How Can I Save More Money for Retirement?
Here are some steps to have more money at retirement, which is probably the bigger picture question:
- Grow income
- Focus on your career
- Obtain additional income streams
- Spend less
- Discern wants and needs
- Practice self-discipline
- Keep the difference between income and expenses
- Invest intelligently
- Remember that rate of return can matter a lot
- Carefully allocate assets and diversify appropriately
- Stay healthy
- Keep in mind that our ability to effectively work may depend on being healthy enough to do so
- The longer we have the capacity to work, the more options we have
For many of you, “I’m preaching to the choir”, as they say :). You might be doing a much better job than me. For everyone else, I’m encouraging you to consider this because frankly, it fits my general assessment of my own needs. I speak from experience.
My Questions for You:
- Do you think a 401(k) (or similar plan) is enough for you?
- Have you run the numbers, considering the variables I mentioned, to get a real idea of what your needs will be?
- What other ways are you approaching saving for retirement