You may have seen this rule of retirement planning in numerous articles: “Save enough to live on 70% of your income.” A significant number of financial planners and respected retirement experts use this benchmark, too, but is it accurate? After you retire, can you really live on 70% of what you’re making now?
If you’ve lived as an adult for at least 20 years, you’ve seen drastic changes in how Americans save for retirement. A shift from a well-funded pension to a 401(k) model that requires more work and investment by the employee is just one of the major changes underway. (See What’s the Difference Between a 401(k) and a Pension Plan?) What will it look like in another 20 years? The trend certainly isn’t for employers to fund more of an employee’s retirement.
Here are some things to consider as you start doing the math of your retirement.
Don’t Count on Social Security Alone
The Social Security Old-Age and Survivors Insurance (OASI) Trust Fund will keep increasing until the beginning of 2020. But by 2035 (in 20 years) it is projected to be depleted – though still able to pay 79% of benefits based on “pay as you go” income from employment taxes. A variety of fixes have been proposed (see Will Baby Boomers Bankrupt Social Security?).
Even if you do get some kind of Social Security payment at retirement, it may well go less far you imagine. The average monthly benefit for a retired worker in January, 2017 was $1,248.67. Start paying attention to those estimated projections you sometimes receive from the Social Security Administration.
Statistics show that the average working household has next to no money saved for retirement. The median retirement savings for working age households is only $3,000 and for households close to entering retirement, it’s $12,000. Americans are collectively between $7 and $14 trillion behind in retirement savings.
Look at How You Live Now
One study found that three out of four Americans are living paycheck to paycheck. Even one out of three people in households earning $75,000 per year report living paycheck to paycheck at least some of the time.
As you do the math, realize that you’re probably already living on around 70% of your official income – income and payroll taxes take a hefty bite out of your paycheck. The average U.S. worker has a 31.5% tax burden, according to the Tax Foundation, a Washington, D.C.-based research organization.
The question is, what will the financial picture look like when you retire? You can expect that you will spend more on some things and less on others.
For most people, the cost of healthcare rises as they get older. So could the cost of insurance. Traditional Medicare won’t cover enough of your health costs; you will need to pay for either a Medigap policy, plus Part D drug coverage – or choose a Medicare Advantage Plan. These could cost more than employer-based healthcare, if you currently have a plan at work. The ongoing repeal of the Affordable Care Act may also cause health related costs to increase. In addition, you will likely get sick more as you get older. It makes sense to budget for increased healthcare costs and hope you won’t end up needing all you’ve slotted for them. A Fidelity study found that couples retiring at age 65 will need about $220,000 (in 2014 dollars) to cover their medical expenses.
Those could well go down. Depending on your state, pension and Social Security income may or may not be taxed at the state level.
If your “combined income” is more than $25,000 as an individual, or more than $32,000 filing a joint return, you will begin having to pay federal taxes on a portion of your Social Security retirement benefits. At higher levels you will owe tax on up to 85% of your benefits. (Avoid the Social Security Tax Trap has details.) On the other hand, you won’t be paying payroll taxes if you’re no longer employed.
Will You Really Spend Less?
Medical costs aside, the conventional wisdom is that you will spend less once you retire, but that may not be true. Look at your life today. Do you spend more money when you’re working or when you have free time? For nearly everybody, the answer is the latter.
Your bucket list likely includes a number of high-dollar activities. You may need to budget more, especially for the first years of retirement. Check out The 4 Phases of Retirement and How to Budget for Them.
On the other hand, if you manage to pay off your mortgage by retirement – or chose to downsize – some of your living costs will decrease. Another option is to relocate abroad, at least for the first part of your retirement, as a growing number of Americans are doing.
Factor in Market Volatility
Remember the financial crisis of 2008? Remember what happened to retirees’ investment accounts? Remember the people who couldn’t retire when they wanted to – and still can’t? The financial crisis taught everybody that relying on the world’s investment markets is necessary, but far from a sealed deal. Many of those accounts have since recovered if the account holders were able to sit out the storm. But timing is everything and older people have less time to earn back losses.
Don’t cut it close. Save more than you think you’ll need so you can weather the ups and downs of the market. See Retirement Savings: How Much Is Enough? and Retirement Planning: How Much Will I Need? for more.
The Bottom Line
As with anything, the more people you ask, the more opinions you’ll receive. Instead of listening to the voices, try this experiment: If you’re currently living paycheck to paycheck, try living on 30% less for the next six months.
If, on the other hand, you have money left over each month, figure out how much more you would need to save (if anything) to bring your living expenses down to 70% of what you spend now – minus any costs associated with children.
Crunch the numbers and use that information to start figuring out what your target income needs to be in retirement. Add up what assets you have now and check with Social Security to get an estimate of your retirement income. Then talk with a financial planner about how you can start working to accumulate what you need in time for when you need it.