Clients ask me: Am I saving enough for retirement? As a life and legacy attorney in Austin, Texas, I provide clients with estate, wealth, and retirement planning advice. So, along with an estate plan, I can provide clients with advice regarding the health of their current retirement plans. I also provide advice to clients about steps that they can take today to make their retirements more secure.
The purpose of this post is to show you how I approach this question. I created two examples below to show you the process.
If this resonates with you, I encourage you to schedule a consultation with me or check out the FREE resources on my website which you may also find helpful.
The first step I take with clients is to determine their smooth consumption rate. This follows from the life-cycle model developed by financial economists. The life-cycle model assumes that you will want to maintain the same lifestyle throughout your life. That is, you will want to consume at the same level in the years before and after retirement. The assumption is that you don't want to either spend too much during your working/saving years and have to reduce your consumption levels during retirement. And that you don't want to save too much during your working/saving years and save all of your excess consumption for your retirement years.
I try and help clients balance their consumption and spending on a path to a successful and secure retirement—a retirement where they can maintain their lifestyle.
Below, using two examples, I outline the steps that I take to help clients achieve their goal of ensuring that they are saving enough for retirement.
The first step is to determine their smooth consumption rate and thereby their smooth savings rate. Let's take an example:
| Anabel | |
| age started working: | 25 |
| savings at starting working age: | $0 |
| current age: | 32 |
| current savings: | $15,000 |
| current wage (post-tax): | $60,000 |
| estimated annual growth of annual wage: | 1% |
| estimated annual return on investments: | 4% |
| estimated retirement age: | 70 |
| estimated age at death: | 95 |
Based on this information, Anabel should consume about $59,894 this year. And she should save $106 this year. (This balance changes each year - these results only apply to her 32nd year, based on the other assumptions. They are not intended as specific financial or legal advice to your unique situation.)
The results may seem surprising. No doubt, it certainly cuts against the advice you hear in the popular press that amounts to you are a bad person because you are not masochistically saving enough until you are in pain with every latte purchase. But, given that Anabel wants to maintain a smooth level of consumption throughout her life and expects to retire when she's 70, she only needs to save $106 at age 32 for her retirement.
Of course, perhaps she feels that she needs an emergency fund or some other priority (saving for a downpayment, for example) - that savings would come out of her consumption.
Let's take another example. Maria is older than Anabel, and therefore has saved more and is closer to retirement.
| Maria | |
| age started working: | 30 |
| savings at starting working age: | $10,000 |
| current age: | 58 |
| current savings: | $453,000 |
| current wage (post-tax): | $76,000 |
| estimated annual growth of annual wage: | 1% |
| estimated annual return on investments: | 4% |
| estimated retirement age: | 70 |
| estimated age at death: | 95 |
Maria started working at age 30. She had a small inheritance of $10,000 that she had invested in an IRA. For Maria, who is nearing the final decade of her working life, she should consume $63,254 per year and save about $12,745 to maintain her current lifestyle in retirement.
The first step towards determining whether a client is saving enough for retirement requires calculating the optimal trajectory of their financial capital.
For Anabel, she's already saved at 32, almost twice her optimal retirement savings for someone in her circumstances at age 37. Hence, she is over-saving, such that she is sacrificing today so she will have a higher living standard in retirement than she currently supports. That's a perfectly reasonable choice - as long as she understands that she is making it.
Clients come to me and often have their retirement savings on auto-pilot, based on decisions they made many years ago.
| Anabel | 37 | $8,060 |
| optimal savings at age: | 40 | $26,982 |
| optimal savings at age: | 50 | $161,881 |
| optimal savings at age: | 60 | $453,726 |
| optimal savings at age: | 65 | $683,634 |
| optimal savings at age: | 70 | $987,889 |
Maria is slightly behind her optimal financial capital trajectory in her efforts to save enough for retirement. At 58, she has saved $453,000, whereas she should have saved $467,019 according to the model. This means that she's living slightly above the lifestyle that she will be able to sustain once she's retired. She can either save slightly more between then and now or fortuitously benefit from a higher series of investment returns.
| Maria | 58 | $467,019 |
| optimal savings at age: | 60 | $555,231 |
| optimal savings at age: | 62 | $654,765 |
| optimal savings at age: | 65 | $827,521 |
| optimal savings at age: | 68 | $1,031,795 |
| optimal savings at age: | 70 | $1,187,559 |
When aiming for a retirement savings target, clients sometimes find it more helpful to think in terms of multiples of their salary rather than thinking in dollar terms.
Because the salary is (hopefully) growing ahead of inflation, this is a bit of a moving target. However, we can estimate the trajectory of the optimal salary multiple for both Anabel and Maria.
Anabel's relative youth and more modest lifestyle mean that she can afford to save more later. When her income increases due to annual raises, she can dedicate more of her salary to retirement savings. In this way, she will maintain a smooth lifestyle during her working and retirement years.
| Anabel | Age | Salary Multiple |
| optimal salary multiple at age: | 37 | 0.12 |
| optimal salary multiple at age: | 40 | 0.38 |
| optimal salary multiple at age: | 50 | 2.10 |
| optimal salary multiple at age: | 60 | 5.34 |
| optimal salary multiple at age: | 65 | 7.65 |
| optimal salary multiple at age: | 70 | 10.52 |
The bulk of Anabel's retirement saving lies ahead of her. But, Maria has saved a considerable amount at her more advanced age. Nonetheless, given her more expensive lifestyle, she must save almost double what she has already saved for retirement. Given her higher income, however, her curve is less steep than Anabel's.
Maria's less modest lifestyle requires 13 times her final annual salary. In contrast, Anabel must only save 10.5 times her annual salary to comfortably fund her retirement.
| Maria | Age | Salary Multiple |
| optimal salary multiple at age: | 58 | 7.63 |
| optimal salary multiple at age: | 60 | 8.42 |
| optimal salary multiple at age: | 62 | 9.25 |
| optimal salary multiple at age: | 65 | 10.58 |
| optimal salary multiple at age: | 68 | 12.00 |
| optimal salary multiple at age: | 70 | 13.00 |
Clients often ask me if they follow the advice above, how much should they withdraw each year? And at different withdrawal levels, what are their chances of success (i.e., not outliving their savings)?
The uncertainty that we have sought to allay above regarding how much one should save becomes how much a retiree should spend once they are done saving.
A Monte Carlo simulation can provide us with a sense of the robustness of a portfolio given different withdrawal rates and assumptions concerning retirement portfolio returns. By randomly simulating thousands of possible retirements, we gain a clearer picture of how much risk a specific withdrawal rate entails.
Anabel's final annual salary will be about $87,500, given the assumption of 1% annual growth. If she saves for her retirement based on the above recommendations, she will have a starting retirement portfolio of about $988,000.
How much should Anabel withdraw each year to ensure that she doesn't outlive her savings?
We can run a Monte Carlo simulation to help answer this question. This model provides us with a series of 10,000 (in this example) randomly simulated retirements for Anabel.
But, let's return to the lifecycle theory, which is motivating this whole exercise. Given that Anabel was saving according to the lifecycle theory, she was saving just enough to maintain a smooth lifestyle throughout her working and retirement years.
We estimated a smooth consumption level of about $60,000 per year.
For the Monte Carlo simulation, let's assume that Maria's post-inflation investment expectation remains at 4% per year. And, let's estimate a standard deviation of 4%.
If Anabel withdraws her final salary from her retirement portfolio, ~$87,900 (a withdrawal rate of about 8.9%), the Monte Carlo simulation provides Anabel with a success rate of only 0.01%. So, 99.99% of the 10,000 simulated retirements, Anabel outlives her savings (should she live until 95).
Bringing the withdrawal rate down to 6.1%, which results in an annual withdrawal of about $60,000, improves Anabel's success rate to nearly 40%. However, that means that she outlives her savings 60% of the time.
For Anabel to achieve a higher chance of success, she needs to invest her retirement portfolio more aggressively. A portfolio with an expected return of 5.25% (compared to 4%) with a 4% standard deviation will allow Anabel to withdraw the $60,000 she requires and push her success rate to nearly 87%.
If Maria continues along her current retirement savings path, she should retire with about $1.2m. In her final year of working, her salary, given the assumption of 1% annual growth, will be about $87,600.
How much should Maria withdraw each year to ensure that she doesn't run out of money before she dies?
We estimated the smooth consumption level for Maria to be about $63,000 per year.
Given the same investment return assumptions we had applied to Anabel, the Monte Carlo simulation warns us that if Maria withdrew her final salary amount of $87,600, she would have a success rate of only 2.81%. So, in 97.19% of the 10,000 simulated retirements, Maria would outlive her savings at such a high withdrawal rate (i.e., 7.3%).
Reducing her annual withdrawal to $63,600 provides a success rate for Maria of 85.67%. Therefore she oulives her money in the 10,000 simulated retirements with this reduced withdrawal rate only 14.33% of the time.
With this withdrawal rate of 5.3% per year, Maria's median number of years to maintain her retirement savings extends to 38. That is 13 years beyond her plan's estimated required 25 years (95 - 70). Moreover, the average number of years Maria remains solvent at this withdrawal rate is 43, with a standard deviation of 16 years. This means about a 68% chance the final portfolio will persist somewhere between 27 years and 59 years.
If you feel that you could use help in determining whether you are saving enough for retirement, don't hesitate to contact me to discuss your specific situation. You can book a FREE 15-minute consultation or a 45-minute consultation for $100.
If you are not ready to contact me, I encourage you to check out the FREE resources on my website, which can help you think about the right questions.
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14425 Falcon Head Blvd
Bldg E-100
Austin, TX 78738
