Saving for the retirement you’ve been dreaming about is entirely possible. It begins with judicious saving and an awareness of potential obstacles you might encounter along the way.
If you’ve already crunched numbers on retirement, you’re ahead of most. According to The Employee Benefit Research Institute’s (EBRI) 2019 Retirement Confidence Survey, only 42% of working-age people have tried to calculate how much they’ll need to save to live comfortably in retirement.
The survey also found that retirees are considerably more likely to say their expenses in retirement are higher than expected (30%) rather than lower (15%).
It’s not hard to see why there’s disconnect between expectations and reality: you have to make a lot of assumptions about your health, longevity and lifestyle in retirement. Below are five assumptions about retirement and the caveats that come with them.
Myth #1: You can always keep working.
The EBRI survey found that 80% 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: 75% said they’ll continue working as a source of income in retirement.
The risk is that working in retirement isn’t always possible. The survey found many retirees end up leaving the workforce earlier than planned—43% the retired respondents in 2019 said they had retired unexpectedly. Sometimes, workers find they have enough money to retire early (33%).
More often, people have to stop working due to health problems (35%), company downsizing or workplace closures (35%, up from 26% in 2017). 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.
Myth #2: 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 may assume that retiring will free you from any work-related expenses and taxes, that you’ve 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. You might want to travel or spend more on gifts, or you might provide financial support to a relative or friend, as 30% of retirees report doing in the EBRI 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.
Myth #3: You’ll be in a lower tax bracket once you retire.
Even before recent changes, marginal tax rates have been near post-WWII lows, and while it’s possible, it’s not a given that you’ll 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 2019 a couple with a pre-retirement income of $157,500 would have to earn about 48% less to move from the 24% bracket to the 22% bracket and about 75% less to move to the 12% 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.
Myth #4: 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, at least if you don’t have time to potentially recover from a downturn. But with the market performing relatively well since, 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 and risk capacity, your retirement spending plan should consider a range of reasonable portfolio outcomes. Based on our capital market expectations, you could plan for five to seven percent returns for stocks and about three percent for bonds.
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. Working with an advisor to complete or update a retirement plan can help.
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.
Myth #5: 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 highly unlikely. The Social Security Administration projects that the current system will be depleted by 2035 assuming no changes, such as means-testing or raising the retirement age. One option would be to reduce benefits for future retirees or tax Social Security benefits at a higher rate.
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.
The bottom line: Be flexible
All things considered, it’s important to start with a plan, but be ready to 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.
Stress-testing your plan and keeping these retirement myths in mind will go a long way toward putting you on the path to your ideal retirement.