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Opinion: Are you saving too much for retirement?

MarketWatch logo MarketWatch 10/31/2018 Dana Anspach

Face it, some people are natural-born savers. Lucky folks.

What about the rest? Well, maybe they live for the moment, had to learn the hard way, or perhaps they’re married to one of those supersaver types and are grateful to let their spouse keep the pocketbook in order.

Amazingly enough, both groups can suffer from guilt, feeling as if they aren’t saving enough. In some cases, this is true. However, there are cases where you could be saving too much.

Let’s look at two factors that contribute to “over-saving”.

One is the idea that you’ll need inflation-adjusted income for life. Yes, inflation is real. However, it does not impact all segments of the population equally. David Blanchett dives into this topic in his research paper, “The True Cost of Retirement.”

The paper segments retirees into three groups; those who spend about $25,000 a year in retirement, $50,000, and $100,000 a year or more. Inflation has the biggest impact on households with lower amounts of annual spending.

That makes sense — when you’re on a tight budget, price increases on basic items such as food and gas have a big impact.

Households spending $100,000 or more have room in their budget to absorb price changes on essentials, and, even though they have the means to increase their income with inflation — research shows this is not what they do. Instead, their spending slows down as they enter the age range of 75 to 85.

When putting all this together, Blanchett summarizes “many retirees may need approximately 20% less in savings than the common assumptions would indicate” and that “retiree expenditures do not, on average, increase each year by inflation.”

How does this fit in with your plan? If you’re following a withdrawal plan such as the 4% rule, this rule assumes you’ll need your withdrawal to increase each year with inflation. That’s highly unlikely. So, here you are saving enough to support a level of cash flow that won’t be needed. That’s obviously not a big problem, as not a lot of bad things happen by saving too much. You’ll just leave more to heirs.

Related video: The easiest way to start investing for retirement (provided by CNBC)

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Still, there is an opportunity cost. Perhaps you work an extra few years thinking you must save more before you can afford to retire — and those extra years take a toll on your health. Or maybe the long hours at the office impact your family and you miss important events. Or perhaps you are already retired and would love to help family members or causes you care about, but you are afraid to spend too much of your nest egg.

You can spot these opportunity costs by customizing your assumptions based on your household demographics. If you’re a household nearing retirement and spending about $100,000 a year, in your retirement projections, a 2% annual increase in spending may be more in line with reality than 3%.

Another rule of thumb that contributes to saving too much for high-income households is the replacement rule of thumb, which generally suggests you’ll need a retirement income equal to 70% to 80% of your preretirement paycheck.

What if you are a household earning $200,000 a year and already saving half that each year? After taxes, you’re living on less than $100,000 already. Yet the replacement rule suggests you need a retirement income of $140,000 to $160,000. That makes no sense at all.

If you’re already a good saver, instead of relying on a replacement rule based on your paycheck, start with your current spending. That may be only 60% of your paycheck. And, this number is what you are used to spending now. If you can maintain that in retirement, that ought to be comfortable.

Or, if you want to spend a lot more in early retirement, you can model extra spending in your younger retirement years, then taper it off as you reach your mid 70s. These customized assumptions allow you to come up with a plan that finds the right balance between saving too much and preserving enough to know you’ll always be comfortable.

“When correctly modeled, the true cost of retirement is highly personalized based on each household’s unique facts and circumstances,” Blanchett says.

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