As a CPA and a former financial advisor, it seems people are always asking me one of two questions: 1) how much should I be saving and 2) what do you think my number is? My usual answer is 15 to 20 percent and more than you think! The people asking the questions are usually looking for free advice and, after I give them the advice they seek, I add the simple disclaimer, “It’s worth every penny you paid.” All kidding aside, the financial discussions on this blog are to entertain and to get you thinking. When it comes time that you actually want to take action you should meet face to face with a qualified advisor, who should take the time to understand your individual situation.
But back to the question of the day, “How much and what’s my number.” Without a traditional old fashioned retirement plan, a defined benefit plan, it’s harder to retire than most people think. Let’s consider an illustrative example with Rich, who graduated from engineering school and started his career in 1973. Rich has completed 40 years of service with Ecorp and is now age 62. Ecorp did not have a traditional retirement plan, but did have a 401k in which Rich fully participated by contributing 18% of his pay. Ecorp added 3% to that for a total savings of 21% of his annual income. He did this for 40 years and he is ready to leave.
Rich’s starting pay in 1973 was $10,512, which was about the average household income in that year so Rich was doing pretty well. With annual raises of 4.1%, Rich’s final pay is now $50,381 which is also the average household income in 2012. By and large, Rich has kept pace with at least one measure of inflation for 40 years. His 401k earned 8% per year and now has a balance of just under a million dollars at $947,272.
A lifelong student of personal finance, Rich has read that he can withdraw 4.0% each year from his retirement savings. This rate should allow him to keep pace with inflation over time, with a 3% raise to cover higher costs each year. That formula puts his retirement draw from is 401k at around $37,891 for 2014. Social Security should give him approximately $12,000 per year if he takes it at age 62 – in other words now. The total of his retirement draw and Social Security equals $49,891 which is pretty darn close to his final year work earnings of $50,381 – pretty much replacing 100% of his final work income in retirement. Rich’s plan is by most yardsticks a huge success.
So the answers to the questions, for Rich anyway, are: 1) he needed to save 21% of his annual income for 40 years (including the Ecorp 3% match and 2) his number was just under $1 million pre-tax retirement dollars.
The challenge, of course, is convincing the kids getting out of school today that they should save 21% of their annual pre-tax income for the next 40 years in a hands-off retirement account. That is the question financial advisors ask each other, ‘How do we do that?’