Are You Saving Enough?

Many people worry that they aren’t saving enough for their retirement. Others are so careful with their money that they save so much they will never be able to spend it all.

Today’s post discusses how to figure out how much you should be saving. We also provide some rule-of-thumb guidance. Since everyone’s situation is unique, if you have questions about your specific circumstances, you may want to consult with a financial adviser.

Retirement Spending vs. Retirement Income

When considering how much to save for retirement, consider how much you anticipate spending and what income sources you may have to cover that spending. After all, if you expect to have more income in retirement than expenses, you are in good shape.

Estimating Retirement Spending

The first step is to estimate how much you expect to spend in retirement. You can estimate that roughly or you can prepare a more exact projection.

Rough Estimate

To get a rough estimate of your retirement spending, start with your current expenses and then adjust them.

Do you have children who will be grown by the time you retire? You will need to reduce your food, clothing and educational expenses.

Do you have a mortgage that will be paid off? Subtract your annual mortgage expense.

Now think about how you expect to spend your time in retirement. If you expect to indulge in more expensive pursuits (extended vacations, hobbies like golf or art) then you should increase your estimate.

Bottom-Up Estimate

For those of us who prefer to be more exact, a bottom-up expense estimate can be prepared. Make sure you consider expenses of all kinds, including:

• Housing (mortgage, insurance, maintenance, property tax, utilities)
• Medical expenses
• Food (groceries and restaurants)
• Auto expenses (lease payments or car payments, gas, insurance)
• Hobby expenses (gym memberships, entertainment expenses, etc.)
• Vacations
• Sundries (household items)
• Educational expenses and gifts

A good place to start is by reviewing your monthly credit card bill. Many of us charge almost everything on our credit cards (it earns us the most points!). If you do this, organize your charges by the categories above to make sure you don’t miss anything.

Also, make sure you don’t forget payments that don’t occur every month or where you don’t pay using your credit card. These expenses can include property tax, maintenance, insurance, and rent.

Retirement Income

Once you have estimated your retirement expenses you can project forward your retirement income to make a comparison.

At retirement, most people have two primary sources of income: Social Security and investment income.

Social Security

How much you can expect to receive in Social Security will depend on your work history and marital situation. Your Social Security benefit is maximized if you delay retirement (as late as age 70) and if you have had a long history of high earnings (Social Security looks at your top 35 years of earnings, adjusted for inflation).

Social Security benefits are significant. The maximum benefit for someone retiring at age 66 in 2018 is $2,788, or $33,456 per year. For a married couple where both parents have long earning histories, that’s almost $67,000.

One common concern with Social Security is whether the government can afford to continue to pay benefits. There is a trust fund the government has where money is “saved” for Social Security, but this year the fund began to spend itself down and it is due to be exhausted around 2034. Because of the funding shortfall, it’s probably safe to assume current workers will not receive the same level of benefits that current retirees are receiving. See here for a nice, albeit dated, discussion of several possible Social Security reforms.

When the Social Security trust fund runs out of money (unless the federal government takes action), to remain solvent it will have to reduce payments by 21%. For this reason, a good rule of thumb is to use current benefit levels and reduce them by 21%.

Here are some additional tips related to Social Security:

• Check your estimated benefits. The Social Security Administration’s website allows you to look up your estimated benefits in only a matter of minutes. Their Retirement Estimator is based off your actual wage-earning and Social Security withholding history. Check out there website here.
• Reduce your benefits more than 21% if you have other income sources or a higher income. When Congress takes action to address Social Security, a 21% across-the-board cut would work, but Congress may reduce benefits more for those with other income sources or a higher overall benefit amount.
• Consider spousal benefits. If one spouse earns substantially more than the other, the lower-earning spouse may receive a bigger Social Security benefit by electing to take the “spousal benefit”, which is 50% of the higher-earning spouse’s benefit. Don’t worry, the Social Security Administration will determine which benefit is better for you.
• Consider delaying Social Security. Social Security benefits can be increased by 8% a year, up until age 70.

Investment Income

Your investments provide income in retirement. To estimate this income, there are two steps to take.

First, project your investments forward until you reach retirement age to see how large your nest egg will grow. After adjusting for inflation, a 4% return is reasonable.

Next, apply a factor to estimate how much investment income you will get from your assets. An old rule of thumb was that you could receive 4% of your assets as income each year. However, in today’s environment, with higher life expectancy and low interest rates, 4% may be too high. Archer Row Advisory recommends starting with a 3% assumption.

Here’s an example: A couple, both aged 51, is looking to retire at age 70. They have $300,000 in investments today, invested mostly in stocks. They expect to return 4% (after inflation), which will result in their investments growing to $630,000 by the time they retire. Using a 3% return assumption, that will provide them with $19,000 in annual income.

Here are a couple additional tips to consider:

• Align your investment returns to your investment approach. Depending on your asset allocation, you can expect your assets to grow faster or slower. If you have a higher risk tolerance (are willing to tolerate more ups and downs), you could expect to receive as much as a 6% return. If you are more conservative, a 2% return is more reasonable.
• Don’t forget additional savings. If you are contributing to your 401(k) in each paycheck or if you save some of your holiday bonus each year, don’t forget to factor that in when projecting your future nest egg.

Other income

Before tallying up your total retirement income, consider other possible factors. Do you have a defined benefit pension? Do you own rental property? Are you the beneficiary of a trust? Will you receive an inheritance from a wealthy uncle?

Is it enough?

Comparing income to expenses can be comforting, surprising, or scary.

If you expect to have plenty of income for your retirement expenses, good for you. Breathe a little easier. (Just make sure you didn’t forget anything when you estimated your expenses!)

On the other hand, if your retirement expenses might exceed your retirement income, go back and look again. Were you overly conservative in your expenses? Did you forget any of your sources of income?

If you still are finding yourself unprepared, consider a variety of tips on how to save money, ranging from eating in restaurants less often to raising your insurance deductibles.

For our clients, one of the first things we do is to prepare a retirement income estimator. We follow the above approach, considering a few additional factors to make the estimate more precise.

If this sounds interesting to you, call Archer Row Advisory at (818) 539-8808 for more information.