Are You Saving Too Much for Retirement?

In my December column, we saw a quick way to estimate how much savings you need to accumulate for a retirement standard of living that matches your current standard (assuming you are not currently racking up debt to support that standard). I have since come across another credible analysis of measuring your targeted nest egg.

This concept, published in early November 2013, comes from David Blanchett, CFA, CFP^®, head of retirement research at Morningstar Investment Management. (Morningstar is an investment research firm, which provides data on about 433,000 investment offerings along with real time global market data on about 10 million stocks, bonds, options, futures, etc.) Blanchett used government data and an investing and life expectancy model to challenge the usual assumptions for retirement cash needs.

Contrary to common assumptions, Blanchett’s analyses also show that retiree spending does not rise and fall simply due to inflation or due to the higher health care inflation rates. Actual spending varies by total consumption. Retiree households that spend at lower levels at the beginning of retirement tend to have increases in spending that are greater than those households that have higher initial levels of spending. These spending levels depend upon three basic things:

1. the total amount of household spending
2. the kind of goods and services they are buying
3. how much money they have to spend

According to Blanchett, “households that are not spending retirement funds optimally will tend to adjust them during the retirement period.” In other words, if you are living within your means, you are less likely to be caught in a situation where you need to cut back on your spending. If you see that your nest egg is dwindling before the end of your life, you will reduce your spending and/or change the goods and services you are purchasing. On the flip side, those with higher levels of retirement resources who begin their retirement spending at lower levels, are shown to increase spending later in their retirement because they are able to do so. Which camp do you want to be in?

This Morningstar paper concluded that using a replacement rate of 70% to 80% of pre-retirement spending would be a reasonable starting calculation for most couples. Also, many of the rule-of-thumb retirement funding models use a fixed period of time (such as 30 years) for an estimate of your total years in retirement. If instead, you were to carefully consider your unique life expectancy and actual spending patterns, you might conclude that your retirement nest egg can be 20% less than the amount calculated with one of the rule-of-thumb retirement funding calculations. The actual goal can and does vary greatly due to the expected differences between your pre- and post-retirement spending.

We are not just talking about total spending here. We are talking about what you are spending your money on. You cannot simply assume a flat inflation rate for all post-retirement expenses. If you are paying for goods and services that are predominantly high inflation items, your expenses will increase more throughout your retirement than if you are spending your money on low inflation items. Using more specific analyses to estimate your unique actual retirement spending can significantly change your estimate of your true financial needs in retirement.

So, what should you do? If you are a do-it-yourself type, in addition to using the rule-of-thumb retirement funding estimate calculations such as the 15.9% method discussed in my December column, you might consider rolling up your sleeves and getting deeper into the detail described above. If you want to put an even finer edge on your funding plans, then get thee to a competent fee-only financial advisor who routinely works on these more complex and more accurate calculations.