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.
For example:
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 But, we have to pay taxes on this money when withdrawn, right?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
Timely Squirreler! Not to mention inflation and 401K fees year after year! I have no illusions about my 401K. I only do a employer match, but I do max out my roth.
You’ve summed up very nicely with the three points!
Moneycone – thanks. 401k plans are important and a good place to invest, but people’s expectations should be kept in check.
I don’t think it’s enough, even if you’re maxing out. I think it’s important to do other things too, like build equity in your home so that by the time you retire, you have lower living expenses (because you have a paid off home).
I know quite a few people who used to use their home equity as an ATM (not so easy to do now). If you have mortgage, consumer debt and car payments come retirement, I don’t see how it can be enough. Those things all should be under control and paid for by retirement time, but I don’t think it is for many people.
I think debt reduction is the other must have item that people should work on in their 30 or 40 years of working that will enable a sound retirement.
First Gen – Agreed that it’s important to do other tings. The home equity as an ATM approach is a path to making life more difficult down the line, particularly when other debt is already in place.
Great comment Frst Gen.
Having a paid off house is one of the keys to my retirement plan. Who knows how much rent will cost where I live in 20 years. I’m guessing a lot.
This year my goal is to get started on my ….oh wait, that was last year’s goal! I’m behind. Not only do I know that even if I max out my 403(b) in my case it won’t be enough, the occupation I’ve chosen hasn’t seen a pay raise in about 5 years (teaching isn’t for those looking to get rich). I’ll definitely be working well into my late 60’s and maybe my early 70’s. My focus is now just building side income streams to supplement the lack of salary. I think a lot of people will be working longer than they think because even for those maxing out their 401(k)’s, if they have any debt at all, they won’t be able to live off their retirement income.
Little House – I think you hit upon some great points here. Really, I have to agree that a lot of people will be working longer than they think, and that multiple streams of income can be a good strategy to help many folks. Best to complement that of course by saving and investing as early and often as possible! But if that hasn’t happened, it’s not too late to do so plus take on the strategy that you’re talking about.
Just 401k is NOT enough to retire on. Although, you can minimize tax impact by taking the required minimum distribution payout instead of a lump sum. I think this will help a bit.
I think we need to invest in Roth IRA, open a brokerage account, and invest in real estate to generate more income stream. A part time job would help tremendously as well especially if it take care of the medical insurance.
retirebyforty – yes, I agree. Unless one hits it out of the park with annual returns, a 401k might be very unlikely to be the only needed retirement source.
Multiple income streams can be for retirement too! I will have Social Security for my wife and myself, IRAs (regular & Roth), brokerage (regular savings) and a pension. Additionally, I can rent out my townhouse for close to $3K per month and any money my blog will generate. The last two is only a back up.
krantcents – yes, multiple streams of income can help. Good point you and Little House have made. Seems like you’ll have some good options in that regard.
Okay, let me play devil’s advocate here.
There are a couple things to keep in mind. First of all, you have the potential to invest in your 401K for your entire working career (let’s say 45 years, as depressing as that sounds to me right now….). Meanwhile, the average person will only be collecting out of the 401K for 20-25 years (also depressing….). And in the meantime, you still continue to earn interest on the investment. So it isn’t as if you stop earning the day you make your first withdrawal. Also, you will likely be in a lower tax bracket upon retiring so that saves some money on taxes. Plus, I suspect we will still have some form of Social Security here in the U.S. (albeit small) so that will also contribute to the overall resources you have.
So to answer your question, I think someone with a healthy 401K could do quite okay in retirement. They will likely not have a mortgage anymore and will have a couple income streams coming in (401K, Social Security, and hopefully other investments, too). As long as they don’t go hog wild in spending I think they could live pretty comfortably.
That said, I have multiple investments as I don’t trust any of them will be enough for me in my retirement years. 🙂 Additionally, I would prefer to NOT have to work a traditional job until I am 65+.
I definitely don’t think contributing to a 401k is enough, but also because I would like my husband to retire before he hits 59 1/2.
We both max out our 401ks right now. Money is somewhat tight for us with 3 private school tuitions, mortgage, etc. However, when I turn 49 or 50, house will be paid off, will only have one child in college instead of 3, and we will be able to start really accumulating for retirement then as our expenses will be drastically reduced. I recognized we won’t have the time value of money on our side, but it is the best we can do. We still save additional money outside of our 33k we put away for our 401ks right now, but not enough. It is a balance of living now and living for later.
I figure I’ll at least need over 2 million (and maybe a lot more if inflation of the future goes hogwild…)
I’m the only one really working in my family (my wife only works a part-part time job getting about 8 hours a week, so it almost all me generating the income. I’ll need to get creative if I want to make it to 2 million.
Social Security would provide a little too (if it still exists)…
I seriously need to rebalance my portfolio, and soon!!!
Posts like this always remind me that a million buck investment account is still a lot of freaking money! Its so frustrating when people say it isn’t.
I don’t know if a 401(k) is enough, but I actually don’t think it was meant to be enough. When it was first created it was made to supplement pensions, but the pensions are gone.
Our 401k will only be part of our strategy. There is also a company pension (if the company lasts that long, or keeps its promise). We plan on living in a smaller, paid-off property, and not needing much in the way of expenses.
As for Social Security? Hah!
Great point! I think most of us need to invest much, much more!