How Much Money Do I Need in My 401k When I Retire?
If you are the kind of person that must plan ahead to ensure your family will have enough money to live on, AND you are not blessed with the gift of foresight, you’ve likely spent a few sleepless nights wondering if you have saved enough for retirement. To go along with those restless nights are a multitude of “what-ifs” that begin to creep in. With all that in mind, this article will explore a few rules of thumb and techniques used to estimate how much a retiree will need to have saved so that their nest egg lasts their lifetime.
Average 401(k) Plan Balance by Age
There are several articles with catchy headlines that are enticing for someone actively planning their retirement. These articles come in a few different flavors, one of which is a type of litmus test inviting you to compare how much people your age have saved in their 401K plan against your own balance. While this is a good starting point, such comparisons may fall short of answering your actual concern, even when you have saved more than the average retiree within your age segment.
A 401K is just one component of a healthy savings plan. Believing that you are OK just because you saved up as much as others is equivalent to checking the air pressure of one of your tires and concluding that you are ready for that family trip, yet one of your other three tires has a flat. Such logic won’t get you very far. To better illustrate my point, let’s look at a summary of data from a study that Fidelity did on this topic:
Average 401(k) balance by age and contribution rate as % of income:
Age 20 to 29: $10,500 - 7%
Age 30 to 39: $38,400 - 8%
Age 40 to 49: $93,400 - 8%
Age 50 to 59: $160,000 - 10%
Age 60 to 69: $182,100 - 11%
Age 70 to 79: $171,400 - 12%
For many hard-working Americans, it is likely that using this benchmark as a guide for how much you should have saved up by your 60’s will leave you wishing you had saved more. To be clear this data is important and very useful for compiling averages, however, such data is not effective towards planning a successful retirement outcome. This type of thinking is a classic “follow the herd” approach. If the entire herd runs off a cliff and you find yourself amongst them, I doubt it will make you feel better knowing that everyone else is also running out of money in retirement.
Salary Multiple Approach
Another flavor of these articles comes in the form of “If you are Y years old, then you should have 6X salary saved”. For example, Fidelity recommends that “you should save ten times your annual income by age 67.” Even though this rule of thumb provides a quick and easy method to check how you are doing, where it falls short is the consideration of individual circumstances and goals of the potential retiree. A better way to contextualize this approach is with a gut-check question, “will this amount of money last me my whole life based on my current level of spending?” If your answer to that question makes you feel uneasy, then it’s time to dig deeper. At the end of the day, the salary multiple approach is not as helpful to those that find themselves in the following situations:
Someone who is in poor health or has a chronic condition that requires a significant budget for healthcare
Longevity runs in the family, which means that a larger-than-average nest egg is needed to stretch those dollars
A person with legacy goals whose intent is to pass a large estate on to family or charity
A retiree who wants to maximize what they spend in retirement so that they bounce their last check
An individual who has dependents with special needs that will require permanent assistance
Future 401K Balance Calculator
If you Google the question, “HOW MUCH SHOULD I HAVE IN MY 401K AT RETIREMENT,” you will undoubtedly come across a few slightly different-looking calculators. These calculators will all have different designs to look unique to their website, but they generally do the same thing – they ask for your age, current 401K balance, and income. They then assume a myriad of other factors on your behalf, which may or may not apply to YOU.
The answer to this question then comes in the form of 3 figures:
Your total balance at your desired retirement age
How much income can you draw from the portfolio
How much income will you supposedly need
There you go, your financial future is spelled out by three mathematical formulas that also rely on an assumed compound growth rate of your account balance, a rule of thumb withdrawal rate, and a percentage of your income adjusted for inflation. Voila!
Sarcasm aside, this may be a helpful approach to calculate what your 401K could grow to, but by no means should this be used as any reliable solution. A more effective way of ensuring you do not run out of money in retirement takes a lot more effort in modeling, planning, and testing your plan for the curveballs life will undoubtedly send your way.
Conclusion
A common theme among these techniques is that they all sound too easy, and that’s because they are. If you are not yet convinced by their fallacy, ask yourself these questions:
Will knowing that you have saved as much as other people your age assure you that you have enough to support your level of spending during retirement?
How certain would you feel about your financial future having run a calculator that requires three inputs to forecast how much you will have at your retirement age (but does nothing to let you know how much you can spend)?
Does the fact that you now contribute 10% of your salary into a 401K plan mean you will have enough to cover in-home care after your spouse passes?
On balance, these rules of thumb and calculators are great tools to grab your attention and generate “clicks” but don’t provide the necessary depth to make meaningful conclusions. While solving your potential concerns at the surface level, there are too many “financial planning” boxes that are left unchecked and too many questions unanswered.
Each person is different. People have different lifestyles, spending habits, values, and goals – all of which determine how much you should save, how much you should have by the time you retire, how much you will be able to spend while enjoying your retirement, and how your estate will pass to your heirs.
Many qualitative parameters cannot be factored in by statistics, calculators, or by pretending that a specific contribution rate to one’s 401K plan will lead to a successful retirement. A successful retirement (and the best way to get peace of mind) is an ongoing effort, requiring professional software to model a retirement plan and continuous checks and testing for the “what-ifs” currently keeping you up at night. Such testing and “what-if” scenarios might include:
What adjustments should I make to my spending if the stock market causes my portfolio to go down by 30%?
What if we go through a period of prolonged inflation? How does that impact my lifestyle in retirement?
Will I have enough income if my spouse dies prematurely? What’s the best survivor option for my pension?
I have my eye on a dream vacation home – does my financial position support this purchase?
How much money can I afford to set aside for my grandkids’ college on an annual basis?
I have an adult child for who I would like to provide economic support to - will I have enough money in retirement to do this?
Once you have determined that a more in-depth analysis is the best path forward for your retirement plan, the question is whether you want to outsource it to a CERTIFIED FINANCIAL PLANNER™ practitioner or do it yourself. For those that enjoy it and have the time, managing your own plan is worth the investment. For others, it’s much easier to hire a professional to help you figure this out. If you fall within the latter category, we can help – click here to learn more.
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