Face it, some people are
natural-born savers. Lucky folks. What about the rest? Well, maybe
they live for the moment, had to learn the hard way, or perhaps they’re married
to one of those supersaver types and are grateful to let their spouse keep the
pocketbook in order.
Amazingly enough, both groups can
suffer from guilt, feeling as if they aren’t saving enough. In some cases, this
is true. However, there are cases where you could be saving too much.
Let’s look at two factors that
contribute to “over-saving”.
One is the idea that you’ll need
inflation-adjusted income for life. Yes, inflation is real. However, it does
not impact all segments of the population equally. David Blanchett dives into
this topic in his research paper, “The True Cost of Retirement.”
The paper segments retirees into
three groups; those who spend about $25,000 a year in retirement, $50,000, and
$100,000 a year or more. Inflation has the biggest impact on households with
lower amounts of annual spending.
That makes sense — when you’re on a
tight budget, price increases on basic items such as food and gas have a big
Households spending $100,000 or more
have room in their budget to absorb price changes on essentials, and, even
though they have the means to increase their income with inflation — research
shows this is not what they do. Instead, their spending slows down as they
enter the age range of 75 to 85.
When putting all this together,
Blanchett summarizes “many retirees may need approximately 20% less in savings
than the common assumptions would indicate” and that “retiree expenditures do
not, on average, increase each year by inflation.”
How does this fit in with your plan?
If you’re following a withdrawal plan such as the 4% rule, this rule
assumes you’ll need your withdrawal to increase each year with inflation.
That’s highly unlikely. So, here you are saving enough to support a level of cash
flow that won’t be needed. That’s obviously not a big problem, as not a lot of
bad things happen by saving too much. You’ll just leave more to heirs.
Still, there is an opportunity cost.
Perhaps you work an extra few years thinking you must save more before you can
afford to retire — and those extra years take a toll on your health. Or maybe
the long hours at the office impact your family and you miss important events.
Or perhaps you are already retired and would love to help family members or
causes you care about, but you are afraid to spend too much of your nest egg.
You can spot these opportunity costs
by customizing your assumptions based on your household demographics. If you’re
a household nearing retirement and spending about $100,000 a year, in your
retirement projections, a 2% annual increase in spending may be more in line
with reality than 3%.
Another rule of thumb that
contributes to saving too much for high-income households is the replacement
rule of thumb, which generally suggests you’ll need a retirement income equal
to 70% to 80% of your preretirement paycheck.
What if you are a household earning
$200,000 a year, and already saving half that each year? After taxes, you’re
living on less than $100,000 already. Yet the replacement rule suggests you
need a retirement income of $140,000 to $160,000. That makes no sense at all.
If you’re already a good saver,
instead of relying on a replacement rule based on your paycheck, start with
your current spending. That may be only 60% of your paycheck. And, this number
is what you are used to spending now. If you can maintain that in retirement,
that ought to be comfortable.
Or, if you want to spend a lot more
in early retirement, you can model extra spending in your younger retirement
years, then taper it off as you reach your mid 70s. These customized assumptions
allow you to come up with a plan that finds the right balance between saving
too much and preserving enough to know you’ll always be comfortable.
“When correctly modeled, the true
cost of retirement is highly personalized based on each household’s unique facts and
circumstances,” Blanchett says.
here for the original article.