A few weeks ago, I kicked off this series of articles on financial rules of thumb. Here, I'll tackle a few retirement-oriented rules of thumb. Retirement is a tricky topic and nuanced enough that following a broad-based rule of thumb could certainly put you at risk.
When it comes to retirement, rules of thumb typically fall into three general categories: what you need to save, what you need to have, and how much you'll spend.
Rules of Thumb: Save 10% for retirement; accumulate a million; you'll spend 80% of your pre-retirement income in retirement
Why: For most Americans, retirement represents their biggest financial goal. Increasingly, retirement has morphed from a rocking-chair lifestyle to something much more active. However, no matter the vision, having the flexibility to control your own destiny is critical. Frankly, no one wants to run out of money in retirement or be forced to make decisions based solely on financial necessity.
Assessment: Retirement variables are nearly infinite. Income streams from Social Security, public-sector pensions and corporate pensions can come into play. Inheritances might factor into the equation. Location is critical. Retirement in San Francisco, California, will look a lot different than San Angelo, Texas. Portfolio performance, spending habits and retirement lifestyle all vary widely. Put that all together, and it's hard for me to jump on the retirement rule of thumb bandwagon. Let's briefly examine each category I mentioned above:
- Retirement savings rate. Ten percent is the most common rule of thumb for retirement savings. If you're 18 or 22 and just launching your working life, committing to 10% and using future pay raises and promotions to boost that rate will probably work out just fine. However, if you're like most Americans and the "I need to start saving for retirement" light doesn't start flashing until you hit your 30s, 40s or beyond, 10% is going to be woefully inadequate. I'm not saying don't do it, but don't expect it to get you where you want to go.
- The magic of a million. Let's just say, it ain't as good as it once was. A million is by no means insignificant, but it can do a lot less for you today than it could 30 years ago. In fact, according to the Bureau of Labor Statistics, a million dollars has lost 54% of its purchasing power over the last 30 years. Conservatively, a million bucks would support inflation-adjusted spending of around $30,000 a year. Add in Social Security and any other pensions and you might be OK, but you won't be living a millionaire lifestyle.
- Retirement spending. Here, the most common number I see is 80%. In other words, plan on spending 80% of what you spent before retirement. Over the years, I've worked with couples who spent a lot more and a lot less than 80%. Yes, there are expenses that go away in retirement. Heck, just the elimination of FICA taxes and retirement savings could possibly take you down to 80%. However, how are you going to fill your time? If you're going to watch TV all day, I've got some good news. First, you won't spend a lot. Second, you'll shorten up your retirement time horizon (you get it, right?). The closer you get to retirement, the more accurate you can be, but I would encourage a line-by-line review of expenses to settle on a number. That number will, in turn, cause you to adjust the size of your retirement nest egg.
With the availability of a wide range of retirement planning tools and, of course, an army of financial planners out there willing to help you flesh out your vision and create a game plan to get there, I'm convinced that rules of thumb are only for those just starting out. The closer you get to retirement, the more wary you should be.