Read the headlines about retirement readiness and you'd think
that at least half of us had forgotten to go to class, do our
homework or study for one of the biggest tests of our lives. When
exam day arrives, we're totally unprepared.
But what if it's just a bad dream and we wake up to find that we
are on track after all?
In fact, researchers are suggesting that assessments of
Americans' retirement readiness are too dire and that most of us
are in pretty decent shape. How so? Some studies underestimate
people's ability to catch up on saving after the kids are grown or
overstate the level of income workers need to replace in
retirement, says a report by Sylvester Schieber, the former
chairman of the Social Security Advisory Board, and Gaobo Pang, of
benefits consulting firm Towers Watson. Others neglect to factor in
resources outside of employer-based retirement plans, such as IRAs
and home equity, or the relatively high benefits that Social
Security pays low-wage earners.
Part of the disconnect is that retirement benchmarks are created
for large segments of the workforce rather than individuals, says
Schieber. "If you're designing a plan that's trying to cover 10,000
people or even 1,000 people, you're going to have to make some
assumptions about how they behave. But every household's
circumstances are different." Families whose situations don't fit
the assumptions, he says, "can't rely on that rule of thumb for a
road map to success."
No one disputes that some portion of the population--maybe
20%--will arrive at retirement vastly unprepared. "Those are
households with lower wages and lower levels of education who have
struggled with basic savings skills, or people who have suffered
terrible economic hardships," says Stephen Utkus, director of the
Vanguard Center for Retirement Research. But overall, the
black-and-white, ready-or-not assessments of past years have given
way to "a more nuanced view of preparedness," he says. "You have to
look under the covers--it's person by person."
Taking a closer look is key to your own retirement planning.
Before you conclude that you've fallen short of the mark or that
you don't dare spend an extra dime of your retirement funds for
fear of running out, decide what you really need based on your own
finances and expectations.
Calibrate your saving
You've probably already gotten the memo to stash 10% to 15% of
your annual income (including any employer match) in your
retirement account, starting with the first month of your career
and ending with the last. That strategy not only lets you take
advantage of the magic of compounding (a no-brainer way to build
savings), but it also encourages the habit of saving and keeps your
contribution level in step with pay raises. At the end of a 40-year
career, you should have enough in the kitty to see you safely
through a 25- or 30-year retirement.
Straightforward as the plan may be, however, it fails to
acknowledge the bumps and potholes that inevitably show up on the
path from young adulthood to retirement age. Kids constitute a
major detour, says Schieber. "People who have a child are probably
going to be consuming differently and saving differently than if
they don't have children and don't intend to have children," he
says. Other savings off-ramps include buying a house, paying off
student debt and suffering a job loss.
How to choose between setting aside money for, say, college or a
house and saving for retirement? "When I talk to people who say
they are going to stop saving for retirement and start saving for
college, I suggest they adjust downward, not stop," says Utkus.
Easing up on retirement savings for a few years shouldn't slow you
down too much if you've fueled your accounts early on.
Eventually, kids grow up, mortgages get paid off, and income
rises. By the time you're in your mid fifties, you may be able to
free up 20% or more of your annual income for retirement savings.
And once you hit 50, you can make an annual catch-up contribution
of $5,500 to your 401(k) in addition to your maximum annual
contribution ($17,500). You can also add $1,000 to your IRA on top
of the annual max of $5,500.
Still, keep in mind that a late-life crisis, such as a health
problem or forced retirement, could affect or even destroy your
ability to recoup. Letting your savings grow over time remains the
recipe for retirement readiness, says Thomas Duffy, a certified
financial planner in Shrewsbury, N.J. "When you make tomato sauce,
you have to let it simmer. Money's the same way."
Assess your target
Retirement planners generally recommend that you have enough
savings at the end of your working life to replace 70% to 85% of
preretirement income. The targets take into account that you'll no
longer be saving for retirement, getting dinged for payroll taxes
or covering work-related expenses, such as commuting costs. To get
you to an 85% replacement ratio, Fidelity recommends that you save
eight times your final salary, minus Social Security and any
Some planners go further, suggesting that you aim to replace
100% of your preretirement income, on the theory that what you'll
save in some categories, you'll spend in others. "Even if you're
not paying payroll taxes, that cost will likely be offset by a new
hobby or travel. Or if you're staying at home more, you'll want to
remodel. There always seems to be something," says Leslie Thompson,
a managing principal at Spectrum Management Group in Indianapolis,
which advises clients on retirement planning.
But maybe your hobby involves reading by the fire, not skiing in
Vail. Or maybe your mortgage will be paid off, or you'll move to an
area where the cost of living is much lower than where you are now.
Given that your biggest spending years are when you're raising
kids, you might get along just fine with 60% of your preretirement
income. A recent survey by T. Rowe Price showed that three years
into retirement, respondents were living on 66% of their
preretirement income, on average, and most reported that they were
living as well as or better than when they were working. If you
scrimp to meet a benchmark designed for somebody else, "you could
be over-saving now and shorting your current lifestyle," says
Then there's a retirement asset you are likely to have in
abundance: time. Maureen McLeod of Lake Como, Pa., retired last
year from her job as a professor at Commonwealth Medical College,
in Scranton. Now, she says, "my husband and I don't eat out as
much, by choice. At the grocery store, I shop around a little more
and compare prices, so I'm spending less on food. We're not so
rushed." The fresh sushi she routinely picked up during the
workweek? She buys it once a week, on senior discount day.
McLeod's experience echoes research done by Erik Hurst, of the
University of Chicago, and Mark Aguiar, of Princeton University.
They report that people save on food costs in retirement not
because they are eating less or buying hamburger instead of steak
but because they have more time to compare prices and prepare
meals. The time payoff extends to other activities, such as
shopping for travel bargains or taking on household chores you
might once have paid someone else to do.
Crunch your own numbers
To get a handle on how you'll spend your time and money in
retirement, make a detailed analysis of what your expenses are now,
says David Giegerich, a managing partner of Paradigm Wealth
Management, in Bridgewater, N.J. He recommends starting the process
about five years before you turn in your office keys. "In the first
two years, don't try to clip coupons, and don't stop going out to
dinner," he says. "Live your life so you can get a realistic
picture of what you're really spending."
Among the obvious expenses: housing, utilities, food, gas,
clothing and entertainment. The not-so-obvious? "Even if you retire
your mortgage, you still have to pay property taxes and homeowners
insurance," says Thompson. Other off-the-radar expenses include
annual payments for insurance premiums and future big outlays for,
say, a new car or a major trip. "People say, 'This is a
one-time-only thing.' But there tend to be a lot of one-time-only
things," says Thompson.
Inflation is a factor you can't ignore. It eats away at what
you've set aside to cover expenses. Says Duffy: "I take a trip to
Colorado once a year to ski. That's probably $2,000 for a seven-day
trip in 2014. How much will it cost 15 years from now after
inflation?" (Answer: $3,116, based on an annual 3% inflation rate.)
You can estimate the impact of inflation on your own expenses by
using the calculator at
Once you've assessed current and future expenses, add up all
your sources of future income. Social Security, based on your top
35 years of earnings, will be a significant piece of the pie, more
so for low earners than for high earners. It replaces 56% of income
for those at the low end of the wage scale and 28% for those at the
high end. (For an estimate of your Social Security benefit, go to
Include in your calculation any defined-benefit pensions you've
accumulated, as well as other sources of income--say, from rental
property or an annuity. Then match total household expenses with
total income. "In most cases, there's a deficit," says Ken Moraif,
a certified financial planner and founder of Money Matters, in
Plano, Texas. The shortfall is how much you'll need to fill in from
retirement accounts and other savings.
The beauty of this exercise is that it gives you a chance to
adjust the plan, or your expectations, before you quit your day
job. Say the difference between your projected spending and income
is $25,000 a year. Multiply the amount by 25 (based on a 25-year
retirement) and you get $625,000. "That's your magic number," says
Moraif. The return on investment would presumably offset inflation.
If you're not on course to have the money by the time you retire,
you'll need to save more or spend less in retirement.
Or you can decide to work longer. Not only does that strategy
allow you to accumulate more savings and shorten the time in which
you'll be tapping your accounts, but it also makes it easier to put
off taking Social Security, producing a bigger paycheck later. You
get an 8% increase in benefits for each year you delay claiming,
until you reach age 70. (This idea makes sense only if you have an
average or longer life expectancy. If not, take your benefits and
enjoy.) Social Security offers numerous other options for
maximizing benefits. (For more information on obtaining a
customized report for your own benefits, go to
Don't ignore the equity in your home as a source of income or a
way to pay unexpected expenses. A reverse mortgage is one way to
tap home equity (see section below).
Add up health costs
One expense that won't go down in retirement is health care. In
2012, premiums and other out-of-pocket expenses represented 14% of
household budgets for Medicare enrollees, according to the Kaiser
Family Foundation--almost three times the health spending of
non-Medicare households. Fidelity estimates that a couple who
retire at 65 will need an average of $220,000 to cover
out-of-pocket health expenses, not including the cost of long-term
But hold the panic attack. Fidelity's number represents the
total a 65-year-old retired couple might pay over their average
life expectancy (82 for the man, 85 for the woman). It is not the
amount they would need on day one of retirement. Most retirees with
health coverage spend about $5,000 a year (or $10,000 per couple)
on Medicare and medigap premiums and other out-of-pocket expenses.
That's not peanuts, but the cost is factored into your
salary-replacement ratio. You aren't tasked with saving an
additional $220,000 on top of it. And health care expenses aren't
unique to retirement. You probably devote a significant part of
your budget to those costs now.
The first step in doing your own cost calculation is to review
your health coverage. If you'll have retiree health benefits from a
former employer, you're lucky--those benefits are increasingly
rare. Most retirees rely on Medicare, including Part A for
in-patient hospitalization and Part B for doctor visits; many also
buy Part D policies for prescription drugs and a medigap policy to
fill holes in Medicare coverage. Dental and vision care are among
the expenses for which you'll have to buy separate insurance or pay
out of pocket.
That's also true of long-term care. Medicare covers very little
of this expense, so if you don't have long-term-care insurance,
consider buying it. Pricey and imperfect, it nonetheless provides
some protection against one of the biggest potential financial
shocks in retirement. The median annual rate for a private room in
a nursing home is $87,600, according to the Genworth 2014 Cost of
Care survey. The median annual cost for assisted living is $42,000.
Options for Covering Long-Term-Care Costs
While you're taking stock, also consider your health status and
life expectancy. Chronic conditions, including cancer, can mean
that you'll pay much more than the average out-of-pocket amount
over your lifetime. Ironically, robust health exacts its own price.
"Some people think, I'm healthier than average, so maybe my health
care costs will be smaller," says Bill Hunter, director of Personal
Retirement Strategy and Solutions at Bank of America Merrill Lynch.
"But the danger is, healthier people live longer, so they're paying
those premiums for a longer time."
Where you live also plays into your retirement math problem.
Premiums for policies that supplement Medicare, and for Medicare
Part D prescription-drug coverage, vary according to coverage
level, the part of the country you live in and the companies
offering them. (To see the range of plans and costs in your area,
go to the
Expect to bring in a decent income in retirement? If your
modified adjusted gross income was more than $170,000 (for married
couples filing jointly) or $85,000 (single filers) in 2012, this
year you'd generally pay a monthly surcharge that raises the Part B
premium from about $105 a month to as much as $336. For Part D, the
surcharge adds up to about $70 a month to the premium in 2014.
Arriving in retirement with a big stash of cash presents yet
another conundrum: How much can you withdraw each year without
running out of money? Two decades ago, financial planner William
Bengen addressed that question, running scenarios that used a
diversified portfolio of 50% stocks and 50% bonds. His conclusion:
If you withdraw 4% in your first year of retirement and take the
same dollar amount, adjusted for inflation, every year thereafter,
you should have money left in your account after 30 years.
Many retirement planners still rely on that formula, not only
because it has generally worked over time but also because it helps
new retirees manage their wealth. "People say, 'We have $1 million.
We're millionaires. We can spend whatever we want.' The reality is,
if you spend 10% a year, you have a high likelihood of running out
of money well before your nineties," says Stuart Ritter, a
vice-president of T. Rowe Price Investment Services.
On the other side, diligent savers can be too conservative when
it comes to tapping their accounts. "If you spend only 1% of your
assets a year, forget about visiting your grandkids--you're never
leaving your house," says Ritter. The 4% rule strikes a middle
ground, he says. "It gives people a starting point."
That said, benchmarks designed to take the long view don't turn
on a dime based on the current investment climate. Retire in a bear
market and you could cripple your portfolio by taking that initial
4%; retire at the beginning of a bull run and a few years in you
might safely bump your withdrawal to 5%. Retirees who are invested
mostly in bonds might be better off starting with a withdrawal of
3% or less in this low-interest-rate environment. Retirees who are
heavily in stocks should be mindful of potential corrections when
they set their withdrawal strategy; if stock prices appear to be at
their peak, you might want to take a smaller percentage to hedge
against a future downturn.
Rather than blindly follow any benchmark, use it as the basis
for devising your own plan, says Thompson, either on your own or
with help. Betterment.com, an online investment service, gives its
clients a tool that lets them tailor their withdrawal strategy to
their goals and risk tolerance. Says product manager Alex Benke,
"You can specify a lifetime horizon, and if you want a very high
chance of success in terms of having your money live as long as you
do, we'll tell you over that amount of time how much you can safely
withdraw from your account." Betterment recommends that clients
check in on the plan once a year. "As the variables change," says
Benke, "the advice changes."
What if you wake up on the first day of retirement and discover
you got a few things wrong after all? You'll adjust, says Utkus. A
standard of living that substitutes weekend getaways for lavish
trips, and dinner out once a week instead of twice, "may actually
be quite satisfying. I'm talking about people who can meet basic
living costs and are thinking about how they manage the rest of
Also remember that no one strategy or formula represents the
complete solution, says Giegerich. "Retirement planning is a
blending. It's a symphony, not just the horn section."