The Max is Not Enough

A common question (at least in my world) is, “Have I saved enough for retirement?” Ironically, lower-income households with little savings tend not to ask this question terribly frequently; they already know the answer. As do the unquestionably wealthy.

No, the question arises more often — and with greater urgency — in the upper middle-income ranks, let us say low six-figures. Households that enjoy a pretty comfortable lifestyle today and would like to keep enjoying that same level of bliss through their dotage.

This is where the harsh math begins. High earners (and spenders) who expect to replicate the same level of lifestyle in retirement — and particularly early retirement — often underestimate just how much they need to save. Just maxing out their employer's 401(k) plan cannot replace a six-figure income, especially for an early retiree.  

Let me illustrate. A 35-year-old married couple earns a combined $200,000 annually and saves $45,000/year (the current 401(k) maximum x 2). That is a fantastic seeming 22.5% of their income. I am definitely impressed. 

Their current level of spending ($200,000 less the $45,000 saved) would, 25 years hence when they are ready for their somewhat early retirement at age 60, require about $254,000, assuming an inflation rate of 2.00%. (And yes, I know, that’s not at all the rate that prevails today! I am very kindly using the Fed’s long-term projection. You may not be a believer.) 

If we assume an investment rate of return of 8%, their nest egg will have grown to about $3.5 million; this implies an annual income stream of $140,000. (I am using the well-worn “4% rule,” which is good enough for the purposes of this illustration). 

You see the problem, right? Of course, once they turn on Social Security, the gap will narrow, and perhaps span the chasm between what they want to spend and what they have available to spend. But until then…

Ah, but you say, “They will have paid off their mortgage by then, thus reducing their income need.” Maybe. Then again, student loans, young children, and later college-age children could easily interrupt that plan. And if they are paying the current US median mortgage payment (somewhere around $2000 a month these days), is the removal of that one expense really going to bridge the gap?

High earner-spenders with early retirement dreams need to be realistic about their post-retirement lifestyle. They need to either plan for significant changes in spending, invest more now for the future than they may think, or consider down-shifting first rather than "full" early retirement. Likely some combination of all three.

Now, there is a key assumption implicit in my rather stylized example and the solution may lie therein. It is that our hypothetical couple’s spending increases through their working years in lock-step with their income. Breaking that cycle — yes, it’s called lifestyle creep — is the essential lever to pull to make their retirement plan work.

Have I depressed you? I hope not! I will always firmly stand by my favorite cliché, “Knowledge is power.” Run the numbers, do the arithmetic for yourself. And then, armed with that knowledge, make your battle plan.

(Hey, I’d love to be in touch with you regularly. My free newsletter contains this blog, as well as other articles written by myself and others. Please consider subscribing by visiting the MoneyByLisa home page.)

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