Are We Saving Too Much?
Yesterday, I read an article on New York Times with the title “A Contrarian View: Save Less, Retire With Enough” [Registration required]. Without reading the article, the message seemed to be very clear: maybe we are saving more than necessary.
If you visit any of the big mutual fund firms’ website, such as Vanguard, Fidelity, or T. R. Price, you will find that they all offer a tool (or a calculator) to estimate how much you will need for retirement, based on, for example, your age, current income level, current retirement assets, annual contribution to retirement accounts, expected returns, and life expectations, etc. Once you provide all these information, the calculator will tell you the estimated number you are going to need for a comfortable retirement. For me, I tried Fidelity’s myPlan a couple of moths ago, and the number I got was a shocking $6M. Vanguard’s calculator gave a slight lowered number, but still at more than $4M (Super Saver has a review of T. R. Price retirement calculator). If I believe what the numbers are telling me, then the prospect of my golden years won’t be pretty.
While the accuracy of these calculators is questionable, they all seem to use one common assumption: your expected income level in retirement relative to your income right before retiring, a number that varies from 70% to 110% in Vanguard’s calculator, 80% in myPlan, and a default of 75% at T. R. Price. Of course, the higher the percentage, the higher the estimated number. So how do they come up with the default percentage? As T. R. Price stated:
A general rule of thumb is that you will need between 60% and 90% of your preretirement income to maintain your lifestyle. A general rule of thumb is that you will need 50% of your pre-retirement income from your investments in the first year of retirement to maintain your lifestyle. We assume that you will increase the inflation withdrawal amount to maintain your purchasing power through retirement.
Again, the explanation seems reasonable. And, in order to reach your retirement goals that these calculators suggest, the only option you have is to save more. Not just save, but invest your savings. And invest your savings with them.
So is it possible that these financial firms all paint a gloomy picture for your retirement just to get you save more and, hopefully, invest your money with them?
The NY Times article says that a small group of economists from universities, research institutions and the government concluded that
the financial industry, with its ostensibly objective online calculators, overstates how much money someone will need in retirement. Some, in fact, contend that financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.
For the financial industry, the paper says, the rule of thumb in determining how much one will need for retirement is:
- The replacement rate: The annual income for a person in retirement should equal to 75% to 86% of preretirement income;
- The withdraw rate: A retiree should spend no more than about 4% of his/her assets each year to make them last.
With these rules, you will find you have to save more, a lot more. And “the financial planning industry prefers to characterize itself as cautious.”
Finally, the paper has this example to show why the numbers you get may not make sense at all:
Fidelity’s Retirement Quick Check calculator says that a 50-year-old person making $100,000 a year with $700,000 stashed in retirement accounts, saving $15,000 a year, would still fall short of the $2.8 million goal that would provide the necessary monthly retirement income of $7,408 that it sets. Its calculations do not include Social Security payments. Fidelity actually recommends saving about $1,000 a month more. It also encourages this person to save more even when more than enough has been saved. It recommends putting away up to $9,749 a month on top of the $15,000 a year already being saved, an impossibility since that would more than consume the person’s entire gross income.
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