To Retire Comfortably, Start Planning and Saving

[This article was originally published on December 20, 2004.  The links were updated on June 20, 2018.]

While their parents were savers, baby boomers have been known as spenders. The results may be disastrous when this huge age cohort reaches to retirement age. With increased longevity and the replacement of traditional pensions with 401(k) retirement plans, saving is more important than ever.

A few examples can demonstrate the 'train wreck' that can happen for people who do not save enough. First, let's take a couple whose situation is as follows:

Age: 45
Income: $100,000 a year
Raises: 5% a year
Inflation: 3%
Return on Investment: 7% before retirement/6% after retirement
Current Savings: $200,000

The couple has little control over these factors. They do have, however, more control over when they retire, how much they save before retirement, and what they spend after retirement. Let's assume they make the following choices:

Retirement Age: 65
Savings Rate: 10% of income (including any employer contribution)
Retirement Spending: 80% of pre-retirement earnings

One of the most debated issues among financial planners is how much people will need after retirement in relation to their pre-retirement earnings. Some contend that retirees can drastically reduce their costs, and some retirees are doing so by moving to less expensive parts of the country. Others argue that with time to travel and partake in other leisure activities, expenses can increase upon retirement. In terms of planning, the figures should factor in Social Security and other sources of retirement income in addition to investments and savings.

What's surprising is that using the 80 percent figure above, assuming a moderate 3 percent inflation rate, the $80,000 a year that this couple would need to retire today will be $145,000 in 20 years.

So what's the result? Our couple will be broke ten years after they retire! While they will have an impressive $1.3 million upon retirement, living expenses will increase from $145,000 a year upon retirement to $194,000 ten years later, and their nest egg will be quickly depleted. They should be aware that while they'll be broke at 75, there's a better than even chance that one or the other of the couple will live past age 90, spending 15 years as a pauper. And this is with a decent savings rate of 10 percent of earnings that exceeds that of most Americans.

So what should they do? Save more, retire later, and economize in retirement. The results are much better if they make the following adjustments in their plans:

Retirement Age: 70
Savings Rate: 15% of income (including any employer contribution)
Retirement Spending: 70% of pre-retirement earnings

Making these changes, at retirement age our couple will have $2.6 million in savings. They will need $146,000 a year to maintain their standard of living. At age 86, they'll still have $1.8 million in the bank.

But what a difference a year makes. If they retire a year earlier, at age 69, by the time they reach age 86 the same couple will have $1.2 million in the bank, $600,000 less.

(These figures were derived from a calculator provided by MFS Investment Management. To access the calculator, click here. For an article with links to other retirement planning calculators, click here.

The moral of the story: save. Use the MFS calculator or others provided by other investment companies, or meet with a financial planner, to determine how much you need to save to achieve your individual retirement goals. And don't put off starting. A dollar saved today is worth two saved tomorrow.

For more on retirement planning, click here.

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