Optimism is a fine thing, but it’s no substitute for careful planning when it comes to saving for retirement. Unfortunately, some people have misconceptions about how much they’ll need to support themselves in retirement—and the steps they’ll need to take to get there.
The Employee Benefit Research Institute’s (EBRI) 2015 Retirement Confidence Survey found that retirees are more likely to say their expenses in retirement are higher than expected (37%), rather than lower (24%). Only 35% say their expenses are about the same as expected. Meanwhile, many working-age people haven’t bothered to think about their retirement savings at all, with only 48% saying either they or their spouse had ever tried to calculate how much they will need to save in order to live comfortably in retirement.
This doesn’t mean that most people’s savings plans are doomed to come up short. Far from it. It’s entirely possible to save for the retirement you’ve been dreaming about. The bottom line is that some judicious saving and planning today can help you avoid some common pitfalls that could make your retirement more challenging.
Here we’ll look at a few misconceptions and rosy assumptions about retirement and the reasons why most people would be better off avoiding them.
- You can always keep working. The EBRI survey found that 67% of workers are planning to continue doing some kind of work for pay after they retire. It’s true that people are living longer and are generally healthier these days, and many retirees find they want to continue working because they like it. But many of the survey’s respondents also gave financial reasons: 81% said they’ll need the income to make ends meet, and 74% said they want to keep health insurance or other benefits.
The risk is that working isn’t always possible. The survey found many retirees end up leaving the workforce earlier than planned—half the respondents in 2015 said they had retired unexpectedly. Sometimes, workers find they have enough money to retire early. But more often, people have to stop working due to health problems, company downsizing or workplace closures. Retiring for any of these reasons could pose serious problems for those who don’t have adequate savings.
Of course, some people continue to work into their 80s or even their 90s. But you’re probably better off structuring your savings plans so that working in retirement is a matter of choice, not necessity.
- You’ll need only 70–80% of your pre-retirement income. If you were saving 20–30% of your pre-retirement income, then the 70–80% income-replacement rule is a good place to start. Otherwise, this old rule of thumb may have outlived its usefulness. It assumes that retiring will free you from any work-related expenses, that you’ll have paid off your mortgage and that your children will be financially independent.
- However, even if these expenses go away, you should still prepare for other costs to go up. For instance, major health care expenses can be difficult to plan for. Medicare doesn’t cover everything, and health care expenses that Medicare doesn’t cover—such as long-term care—can add up quickly. You also might spend more on other things. For example, you might want to travel or spend more on gifts. Or you might provide financial support to a relative or friend, as 20% of retirees are now doing, according to the EBRI’s survey.
- The bottom line is that it’s safer to aim at covering 100% of your pre-retirement income, less whatever you’re saving for retirement. As with any general rule, there are plenty of exceptions. So be sure to sit down and fine-tune your retirement budget as the time draws near.
- You’ll be in a lower tax bracket once you retire. Even with recent increases, marginal tax rates are still near historic lows, and it’s unlikely that most people will move to a lower bracket in retirement. Even if they do, the change will likely be just a few percentage points rather than a major shift. For example, for 2015, a couple with a pre-retirement income of $155,000 would have to earn less than half that amount to move from the 28% bracket to the 15% bracket. Sure, your salary will be going away (as will FICA taxes), but you will still have income, such as distributions from retirement accounts and Social Security benefits. (For married couples filing jointly, up to 85% of your Social Security income may be taxable if your modified adjusted gross income is more than $44,000.)
- You should remember that as recently as the 1980s, the top federal tax bracket was a whopping 70%. While tax rates aren’t likely to return to that level anytime soon, it is possible rates could rise in the future. So if your taxable income remains the same in retirement as when you were working, higher rates in the future could boost your tax liability. Unless you have a very high pre-retirement income, it’s safer to assume that you will keep paying taxes at roughly the same rate after you stop working.
- The stock market will save you. The market declines of 2002 and 2008 should have convinced most people that this is not a reliable assumption. But with the market rising again, it’s easy to forget that you may not see the kinds of returns going forward that you saw in the 30 years prior to 2000. It’s always better to be cautious when making assumptions about the market’s performance, and to have some cash and more stable investments in your portfolio to help you weather a bear market.
- Whatever your risk tolerance, your retirement spending plan should consider a range of reasonable portfolio outcomes. You could plan for high-single-digit returns for stocks and about half that for bonds (despite today’s extraordinarily low interest rates). But don’t assume the same return every year. Market returns fluctuate and a bear market in the early years of your retirement could have a significant impact on your ability to sustain cash flow.
- Market gains can help your savings go further in retirement, but they aren’t a replacement for pre-retirement saving. And make sure that you have a cushion of less volatile investments in place when you reach retirement.
- There’s always Social Security. Some people head into retirement thinking they’ll be able to rely on Social Security to cover most of their needs. Others doubt that Social Security will even exist by the time they retire. Both scenarios are too extreme. The Social Security Administration projects that the current system will remain sound through 2036, but beginning in 2037, benefits could be reduced by 22% and may continue to decline annually if no changes are made to the program.
- Social Security is likely to be a valuable resource for many retirees, but don’t get carried away. No matter what, Social Security is going to cover only a portion of your retirement spending, and you will need additional savings to bridge the gap.
All things considered, it’s important to be flexible and adjust your plans when needed. Don’t get into a situation where your retirement works only if one set of assumptions turns out to be true. But you should also avoid the kind of pessimism that might cause you to scale back to the point where you’re sacrificing more than necessary.