Retirement Finances


Saving Too Much?

An income equal to 70 percent of current salary may be more than you need

By Lawrence Bivins

Steve and Patty Dischinger are not your typical thirty-somethings when it comes to their plans for retirement. Unlike many couples their age, they've heard and heeded the advice about starting early, saving aggressively, investing wisely, “maxing” out their 401(k) contributions and directing a healthy portion of their earnings in tax-protected savings accounts. They look forward to enjoying a comfortable lifestyle when they retire, which they figure will be around age 60.

Being on top of their finances should come naturally to the Chapel Hill couple. Patty works in financial management for the City of Durham while Steve helps IBM chart its vision for the next-generation Internet. They've always done their own taxes. Both hold MBAs from top institutions, and neither are anyone's fools.

So why do they worry they won't have enough saved up for their golden years?

For years they've heard the standard advice that by the time you retire you should have savings and other financial resources that will generate an income equal to 70 percent to 80 percent of pre-retirement earnings.

“I'm an engineer by nature and like to apply models based on proven assumptions,” explains Steve. “I kept seeing the 70-80 percent planning assumption in financial articles and books but never a detailed analysis that was built from the bottom-up.”

Dischinger even fired off an e-mail to a prominent personal finance columnist inquiring about the 70 percent solution. The guru's response: it's only a “guestimate” and that he knew of no other way to gauge retirement budgeting.

Many financial planners recommend the 70 percent figure because it's easy, in theory, to understand. It's based on the fact that many current expenses will decline or end entirely at retirement -- gas for the daily commute, a business wardrobe, restaurant lunches, professional society dues and other similar outlays. And let's not forget that once you get that gold watch you won't have to continue saving for retirement.

Sounds reasonable enough, but the problem is that the experts can't agree on the percentage figure. Most say 70. Others say 80 or 90 percent when exploding health costs are factored in. The figure may go to 100 percent, some warn, when you consider all the hired help you'll need to handle housekeeping, yard work and light repairs around the house that were do-it-yourself tasks in your younger years.

On the other hand, some other advisers say it's less, much less.

“The main reason people need less than they think is that two of their major cost centers go away: children and mortgages,” according to Ralph Warner, author of “Get A Life: You Don't Need a Million to Retire Well (Nolo Press, 1999). “Most of the conventional analyses don't make that distinction.”

Warner, who is critical of both the financial services industry and financial planning writers, claims that 40 percent to 60 percent of current income will be sufficient for many retirees to live on comfortably. Failing to arrive at a sensible assessment of retirement income needs, Warner believes, can result in either not saving enough or sacrificing important present needs to chase the Holy Grail of an enormous retirement fund. “People may also adopt a schizoid plan that ends up doing a little of both,” he adds.

At the heart of the debate is a question that only you can answer. How much you will need in retirement has more to do with your vision for post-career living than anything else, and no one size fits all.

If done properly, sketching together projections for how your budget will change as middle age yields to retirement age makes good sense as a starting point for retirement planning.

“We believe the first step with our retirement planning clients should be sitting down with them and talking about their current lifestyle and the changes they anticipate as they move into and through retirement,” says Shella Gatling, a certified financial planner with Centura Securities in Durham. “We attempt to find out where people really are in the life-cycle,” reasons Gatling, who handles training and continuing education for the Rocky Mount-based firm's brokers and financial planners.

Gatling and other financial service professionals see the 70-80 percentage figure as more of an average across the retirement years. “Most people go through stages of retirement,” Gatling says. “They may have a few years where their expenses are equal to what they were before retiring. They may later go down a bit as the person travels less, then rise as health needs increase.”

Life expectancy is an important but tricky factor. Relying on insurance company actuarial tables may not be terrible helpful in getting an accurate estimate of how long you'll be around.

“It's very difficult to do individual-level projections about life expectancy,” says Eric Stollard, research professor of demographic studies at Duke University.

Sketchy though they are, longevity data provides a wake-up call to people who may not realize they could ultimately spend three or four decades in retirement. “About half the people who make it to age 65 go on to age 85,” according to Stollard. “Half of them go on to age 91. Half of those people will survive to age 98.”

And those numbers themselves are gradually rising. About one additional year of life expectancy at age 65 is gained each decade. Today, for example, a 65-year-old woman can expect to live another 20 years. A 45-year-old woman should therefore anticipate another two years on top of that by the time she hits 65.

Pension coverage is another variable. Slightly more than half of all U.S. workers are covered by some type of pension plan, though in many cases benefits are not indexed to keep up with inflation.

“There are so many different types of (pension) structures out there that its not a given that inflation protection is built-in,” explains Martha Sadler, a certified pension consultant with McGladrey & Pullen in New Bern. Plans designed for large corporations and government employees usually contain indexing features. Voluntary retirement plans such as 401(k)s and 403(b)s, increasingly the norm, do not have inflation-protection built-in.

The good news is that Social Security, which covers well over 90 percent of the workforce, does provide annual benefit increases to keep pace with inflation. “Benefits are fully indexed, but you have to understand what you're indexing,” cautions Martha Lambie, Raleigh-area district manager for the Social Security Administration. The annual cost-of-living-allowance (COLA) the system provides is tied to the overall rise in the Consumer Price Index (CPI), which may not fully account for the unique spending needs of retirees. “There's been some talk in Congress about the fact that the COLA doesn't really represent increased costs to the retiree population, but there's not been any action yet (to correct) this.”

So how does a budget change when one enters retirement? One way to tell is to look at aggregate spending habits of various age groups.

Housing

This is one of the most expensive and most difficult items to forecast. Nearly 80 percent of homeowners age 65-74 have paid off their mortgages and own their homes free and clear, according to Kiplinger Associates. In 1998, for example, the average consumer age 55-64 spent $2,249 on mortgage interest while those age 65-74 spent only $662, according to the Bureau of Labor Statistics (BLS).

But housing means more than just interest payments. Property taxes will remain constant or may even go up after your retire, assuming you don't choose to downsize into smaller digs upon retirement. Nor are your homeowner association dues likely to go down. The same is true for utilities and insurance. Ditto for maintenance, repairs and household services, which drop off slightly during a person's late 60s and early 70s, but spike back up for consumers in their late 70s.

Transportation

For many individuals, transportation costs will spike during the “honeymoon” phase of their retirement when they take trips they've long looked forward to. For others, whose careers have required a lengthy daily commute, car payments and daily parking fees, there may be immediate savings. Overall, however, those expenses ultimately will decline. Total transportation costs in 1998 for those age 55-64, BLS data point out, were more than $7,000, but for the 65-74 age group those costs were slightly less than $5,000 and just under $2,900 for those 75 and up.

Here, as elsewhere, discount programs targeted at seniors make a difference. Amtrak, for instance, reduces its lowest fare by 15 percent for anyone over age 62, good anytime for any of its destinations. Similarly, Morrisville-based Midway Airlines markets a Senior Travel Coupon Booklet containing considerable savings for passengers 60 and older.

Entertainment

For many retirees, budgeting for such things as recreation and travel is more a function of lifestyle and health status than available dollars. Even for able-bodied seniors, spending on high-end travel and leisure activities usually declines eventually as the thrill wears off. BLS numbers show a consistent and gradual decrease in dollars spent on entertainment from early middle age onward. In 1998, those age 35-44 spent an average of $2,215 on such things. Those 75 and older spend less than one-third of that amount. Senior discount programs, at least for those willing to ask about them, offer reduced rates at thousands of museums, movie houses, theaters and golf courses. Retirees are also given a break at most hotels, cruise ship lines and rental car agencies.

Health Care

Now for the bad news: expect to pay significantly more for health-related needs as the years go on. Even with Medicare, the generously subsidized federal health insurance program for the elderly, medical costs spike dramatically in retirement and never decline. That's generally because Medicare covers a large portion of doctors' fees and hospital charges, but leaves seniors on their own when it comes to prescription drugs, dental services, hearing and vision needs, and — the big one — nursing home care.

“There's a clear trade-off between the travel-related budget line and the medical cost line as our clients move from the immediate post-retirement years into late life,” says James Richardson, a Raleigh certified financial planner who specializes in retirement preparation. Richardson tracks the spending patterns of his retired clients annually in an effort to ensure none outlive their savings. “As health status declines, more and more dollars flow from the entertainment area into the health area.”

Making matters worse is the prospect that health inflation continues to gallop far ahead of overall price levels. From October 1984 through October 1999, the cost of medical care services -- a basket that includes fees charged by physicians and hospitals, medical supplies, health insurance and prescription drugs — soared at an average annual rate of 9.9 percent while the overall CPI rose at a manageable 4 percent yearly clip.

“Unless there is new technology for the delivery of medical care services, I think there is a good chance the rate of inflation in health care could increase even more,” says Michael Walden, professor and extension economist at N.C. State University. The migration of 77 million baby boomers into retirement will spark a dramatic increase in health care demand, Walden predicts. “The issue is whether supply can keep up.”

Just when you think things could get no worse, another alarming trend comes calling. “A lot of companies are eliminating retiree health benefits,” adds Centura's Gatling.

Taxes

Conventional wisdom holds that as your income drops in retirement, so too will your marginal tax rates. Regarding today's retirees, Uncle Sam and his counterparts at the local and state levels have indeed had to settle for less. The average combined income tax bill for those 65 and older was about one third the $3,200 average for all consumers in 1998.

But it's important to point out that BLS and other government data are based on snapshots taken of various cohort groups, not a longitudinal tracking of changes that occur to individuals over time owing to some aging- or retirement-related experience. Taxes are one line item where this distinction may be an important one.

“This is an area where I expect differences to occur with regard to baby boomers in retirement,” says Richardson. “What you have to remember is that today's pension beneficiary probably participated in a defined-benefit plan as opposed to a defined-contribution system that will be the norm for future retirees.”

What troubles Richardson is the prospect that instead of receiving the predictable monthly pension payment that a traditional plan provides, boomers' retirement income will largely be based upon the amounts accumulated in their 401(k) plans. “Under the Internal Revenue Service rules, required minimum withdrawals are calculated annually based upon life expectancy. Because funding into the plan during the working years was done on a pre-tax basis, boomers may end up having to take huge payments from their retirement plans — more than they need — and all of it taxable from the first dollar.” The result: an unpredictable tax bracket at best and a steeper one at worst.

Adding insult to injury is the reality that retirees don't typically enjoy many of the tax breaks that working stiffs do. There's no home mortgage interest deduction once the mortgage is paid off. No longer will 401(k) or IRA contributions reduce taxable income. Dependent children are likely long gone. Nor will career-related job hunting and relocation expenses be an option. Lifelong learning credits won't be of much use.

“The only real break left is the charitable deduction -- either give your money to the government or give it to someone you like,” laughs Richardson, who forecasts yet another tax whammy for boomers. “I see taxation of retirement benefits on the rise as boomers retire. It's likely that wealthier boomers will be called upon to finance the increased social costs government will encounter in dealing with such a huge older population.”

Education

Not long ago, most educators believed that after a certain age, a person was incapable of learning. Seniors also bought into the belief. But today, learning in retirement is a rapidly emerging phenomenon. With college tuition payments for their children now a hazy memory, many retirees are returning to the classroom for their own enrichment. But statistics point only to decreases in the amount older Americans are spending on education. The likely reason? They aren't paying tuition.

Tuition and fees for North Carolina residents age 65 and older are waived for most credit- and non-credit courses across the 59 campuses of the state's community college system. Much the same is true at the 16 campuses of the UNC System. Even private colleges are extending an invitation to seniors. Guilford College, for example, reduces it normal tuition of over $700 per course to a mere $25 for students over age 65.

The Bottom Line

After all is said and done, what's the bottom line on saving for retirement? Save early, save well and save wisely, just as before. More importantly, spend some time thinking about where and who you'd like to be when you retire. “The really important part of retirement has nothing to do with money,” concludes Ralph Warner. “We should focus instead on those things that will make those years more fulfilling: health, spirituality, family and friends, and a full plate of interesting things to do.”

Others agree that the worst possible course is to obsess about retirement planning. Richardson recommends keeping a sense of humor throughout the process. “There's something planners like to call the `Monte Carlo effect' — nobody really knows what they'll wind up spending in retirement.”

Lawrence Bivins is a Raleigh-based freelance writer.

COPYRIGHTED MATERIAL. This article first appeared in the January 2000 issue of North Carolina Magazine.