Cheer Up, You’re Not as Far Behind on Retirement Savings as You Think

If you’re like the average American, retirement savings has you totally bummed out. The Employee Benefit Research Institute (EBRI) reports that 27 percent of Americans are “not at all confident” about having enough money for a comfortable retirement, and only 13 percent are “very confident.”

You don’t have to go far to find other scary retirement savings figures, like how the average working person in their 60s has only $144,000 in their 401(k). At a recommended 4 percent withdrawal rate, that’s enough to produce $5,760 per year in retirement income. Ouch.

I don’t want to minimize how scary it is out there for the retirement saver. But I’m an upbeat guy, and I want to inject a Pollyanna-tinged ray of sunshine into this gloomy glade. You may not be as far behind on retirement savings as you think you are, and if you are genuinely behind, it may be easier to catch up than you think.

The standard model of retirement planning assumes you’ll take money you’ve accumulated in your 401(k) and other investments and withdraw it gradually over the rest of your life to replace the salary you were receiving at the time you retired. In order to keep up with inflation but minimize the risk of outliving your money, various studies have found that you can withdraw 4 percent of your portfolio in the first year and an equivalent amount, adjusted for inflation, each year thereafter.

In math terms, the standard model goes something like this:

Your salary × 25 = Your retirement goal

You see this formula all the time. Here’s how the Motley Fool put it: “So if you’re planning to live comfortably on $50,000 a year in retirement, you’ll need to have $1.25 million saved by the time you get there.” Plenty of online retirement calculators make the same assumption.

But even if you assume Social Security will disappear by the time you retire, that number is way too high. Here are five reasons why.

1. You won’t be saving for retirement any more when you’re retired

If you’re putting 10% of your salary into your 401(k), that’s 10% you won’t need to replace in retirement. This is an absolute no-brainer, but it has some interesting consequences we’ll get to in a minute.

2. You’ll spend less, year after year

People in their 80s are different from people in their 30s, 40s, and 50s in plenty of ways beyond wise aphorisms and Metamucil. As we get older, we spend less.

In a 2005 paper, financial planner Ty Bernicke offers evidence that spending drops off precipitously as we move into our 60s and 70s. (People in the 55-64 range even spend less than those aged 45-54.)

That’s even taking into account the fact that the elderly spend more on health care, and it holds even for wealthy retirees whose net worth is steadily increasing. That is, even retirees who are sitting on an ever-growing pile of loot for their heirs tend to voluntarily decrease their spending.

Facing down this data is kind of unnerving in the same way thinking about wills and life insurance is unnerving: I don’t want to think about slowing down, traveling less, spending less on food and entertainment, any more than I want to think about eventually spending zero on these things for eternity. But taking what Bernicke calls a “reality” approach to retirement planning could enable a typical retiree to save less or retire earlier.

3. Your tax bracket will go down

Most retirees are in the lowest tax brackets. Money you take out of your 401(k) or traditional IRA is taxable, but Social Security is only partly taxable, and Roth IRA distributions aren’t taxable at all. Sure, the tax code is going to change a dozen times between now and when you retire, but chances are, your taxes are going go down the day you kiss that cubicle goodbye.

If you’re budgeting for retirement based on the assumption that you’ll spend as much on taxes as you do today, you’re budgeting too much.

4. You can always annuitize

If your retirement savings are marginal (but not way below par), you can turn them into a lifetime monthly income stream by buying a single-premium immediate annuity (SPIA) from an insurance company. Basically, you hand the money over to an insurance company and it gives it back, with interest, over the rest of your life. If you live longer than the insurance company expects, you win. Even in the current low interest rate environment, an inflation-adjusted SPIA pays over 4 percent annually if you annuitize at age 65.

Annuities are backed, up to a maximum, by a state guaranty agency. And you don’t have to make an all-or-nothing decision at 65. You can annuitize some of your money—maybe enough to guarantee a minimum base level of income you don’t want to drop below—and invest the rest. You can wait until you’re 70 and see how things look then; the older you are, the bigger the monthly payout from a SPIA. And interest rates could go up.

5. Every dollar you save reduces your current standard of living

Ah, “reduces your current standard of living” is such a negative way to put a beautiful concept.

Here’s what happens if you decide to bump up your retirement savings by 2 percentage points today—say, from 8% of your paycheck to 10%. For a couple of months, you grumble about your smaller paycheck. Then you get used to spending slightly less and forget about the supposed good old days. Your retirement account will grow faster, and by the time you need to draw upon it, you’ll be able to make smaller withdrawals thanks to your lower standard of living.

In other words, you have more savings to replace less spending. It’s like the universe just gave you a 401(k) match. If you took that extra 2 percent and gave it to charity or sent it to me every month instead of saving it, you’d still be better off, because you’d be saving at the same rate as before but have less spending to replace.

Hmm, did I just prove you’d be more financially secure if you sent me some money? I reckon so.

Matthew Amster-Burton is a personal finance columnist at Find him on Twitter @Mint_Mamster.