Thursday, April 24, 2014

Back to How Much Savings is Needed

The primary focus of my posts is on how much accumulated savings can be spent each year in retirement.  But since that amount is generally linked with how much accumulated savings one has, readers will forward me articles aimed at pre-retirees looking for advice on how much they need to have saved at retirement. 

I have addressed this issue somewhat in this article and most recently in my post of May 31 of last year where I concluded that if you don't have sources of retirement income other than Social Security, you probably shouldn't be too worried about over-saving until you have accumulated at least 10 times your annual salary. 

This past week, I read "Have You Saved Enough to Retire?" and "Why not even $1 million may not be enough for retirement".

The first article references Fidelity's very optimistic "8 times" rule, which claims that if you are an "average worker", retire at age 67, die at age 92 and accumulate savings of 8 times your pay at retirement, you can enjoy total retirement income (Social Security and withdrawals from accumulated savings) of approximately 85% of your gross pre-retirement pay.  Based on the recommended assumptions in this website (5% investment return, 3% inflation and payments until age 95), I come up closer to a 70% replacement rate.  Of course, Fidelity assumes that you will earn an average nominal rate of return of 7.5% per annum with 2% inflation (a real rate of return of 5.5% per annum).  If I input Fidelity's assumptions in the "Excluding Social Security 2.0" spreadsheet on this website, I do get a replacement rate of 88%, so, at a minimum, I can confirm Fidelity's calculations, if not the reasonableness of their assumptions.

The second article argues that $1 million in accumulated savings at retirement may not be enough.  Whether it is enough will depend on many things, but I can provide some spending numbers associated with having $1 million in accumulated savings and you can make up your own mind.  If Social Security income is around $30,000 per year (about the maximum in 2014) and no other retirement income sources exist, then total annual gross retirement income (Social Security and withdrawals according to the approach outlined in this website) for an individual retiring at age 67 with $1 million of accumulated savings will be about $75,000 to $80,000 depending on how much of the $1 million is used to purchase an immediate annuity (based on current annuity purchase rates) and/or whether the retiree delays receipt of Social Security benefits.  This level of retirement income will probably be enough for many individuals who retire in the near future.  Keep in mind, however, that it assumes retirement occurs at age 67 with $30,000 in annual Social Security income.   

As an actuary, I tend to be fairly conservative.  I wish I could tell pre-retirees that you don't need to accumulate all that much to afford to retire, but in all good consciousness, I just can't.  If you want, you can certainly plan your retirement by assuming that you will earn a 5.5% real rate of return on your retirement assets, there will be no reductions in Social Security benefits, or you will retire later than age 67, etc.  Or, you can follow the more conservative path and save more now for your retirement.