Are You Actually Putting Too Much Money Away for Retirement?

If you’re saving for retirement, good for you. You’re doing something that, by all accounts, a lot of Americans aren’t. In fact, the National Institute on Retirement Security estimates that 45%, or 38 million working-age households, do not have any retirement account assets at all.

In a world where most people aren’t saving enough, is it possible you’re actually putting away too much for your retirement?

If you’re following industry standard advice from investment advisers, you could be, according to David Blanchett, head of retirement research for Morningstar Investment Management.

“It’s not that you don’t need to be saving, but if you’re forgoing enjoyment in your life now because you feel pressured to save millions of dollars for retirement, you might want to rethink your plan,” Blanchett said.

Is Conventional Wisdom Just Plain Wrong?

The most common approach to figuring out how much you’ll need for retirement is to apply a generic “replacement rate” to your pre-retirement income, such as 80%, to get the desired retirement income needed, he said. Replacement rate is the pre-retirement income that is paid out upon retirement. But the true cost of retirement is actually highly personalized.

“We find that the actual replacement rate is likely to vary considerably by retiree household, from under 54% to over 87%,” Blanchett noted in his 2013 report.

“I always say that retirement is the most expensive purchase you’re ever going to make,” Blanchett said. “When you go online and you use a lot of these tools, they make very generic assumptions about how long you’re going to live, rates of return, etc. It really makes sense to take the time to model out what you’re actually going to need for retirement.”

As an example, Blanchett notes the rate of inflation. On average, consumption tends to decline among retirees and doesn’t actually keep pace with inflation.

“That’s a pretty big impact in retirement if you draw those differences out over a 20- or 30-year time horizon,” he said.

This holds true not just for self-directed investors, Blanchett added. Financial planners and advisers also can overestimate the amount of retirement money a person needs. There have been numerous reports over the last few years on the “saving-too-much” theory that suggest some advisers may be intentionally scaring investors into saving more than they need to so they can profit from managing more of their money. Yet Blanchett said the issue is less nefarious than that. Advisers simply want to ensure they’ve provided the best, safest advice to their clients.

“Advisers aren’t telling you to save more just so they can add basis points to your savings,” he said. “To me, if I’m an investment adviser and my client is paying me to get to retirement, I want to make sure they’re successful. I don’t want them to sue me because I didn’t tell them to save enough or something else is wrong with my projections.”

The New Standards That Could Benefit You

That conservative approach could become even more pervasive thanks to a Department of Labor announcement just this week that financial advisers will now be held to the “fiduciary standard,” a rule requiring financial advisers to put their clients’ best interests ahead of their own profits. Currently, only financial professionals and firms registered as investment advisers with the Securities and Exchange Commission or individual states follow that rule. Soon, all financial professionals offering investment advice for retirement accounts — including 401(k)s and IRAs — will be included.

“Some advisers, in my opinion, are just way, way too conservative,” Blanchett said.

So if the typical “replacement rate” model isn’t always suitable for retirement plans, how do you figure all the unknowns to know how much you’ll actually need for retirement? First and foremost, talk to your adviser.

“It’s a difficult conversation — it really requires an adviser who understands how these projections work, and at a minimum you want to work … with someone who understands why the model is the way it is, what assumptions they use, etc.,” Blanchett said. “Replacement rates are a really great starting point — 70% to 80% is about right for most people, but it doesn’t really make sense to use replacement rate when you’re approaching retirement. When you’re close, you have an idea of what your consumption is, and the question becomes ‘what’s going to change when I retire?’ If you’re someone who’s going to pay off their mortgage, has been saving 20% of your pay and who has kids who are paying for school, when you retire, your number could be 40%.”

He adds, “Now, if you’re 35 years old, replacement rate definitely makes sense, because who knows what’s going to happen 30 years from now when you retire.”

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