One of my favorite questions to ask in group meetings is, “Who here has recently bought a car?” When the brave soul raises her hand, I ask her to calculate all the time she spent on the process— work she did to research the car, negotiate, and then purchase the car. Usually it falls in the range of 20-40 hours.
Then I open up a question to the group: “Does anyone in here believe that this group, collectively, has spent as much time or more making the decision on how much to save and where to put those savings?” The audience members emphatically shake their heads.
The most important decision of our lives, how much to save for retirement, has been an afterthought for many of us. For people barely skating by and living lives adapted to their salaries, the subject is painful and therefore delayed. For people who have thought about it at all, they just think about it a little. For instance, a family making $80,000 per year might pick up on “maxing the match.” It’s the notion of saving a percentage that fully captures the “free” money offered by the company. I will offer an example later. For high income doctors, they might send a ton of money to retirement and hit the $22,500 regulatory maximum. They skip the whole thinking about saving percentage to the more exciting question of how to invest their money. Interestingly, in both cases, while they are seemingly saving enough, they are not likely going to be able to retire on their own terms.
MODEST EARNER: DETERMINING YOUR SAVINGS RATE
Let’s take the case of the person making $80,000. He has a stay-at-home spouse and two kids. Things are tight, and he had not saved for retirement up until that point. When he joined his company at age 30 he was thrilled to get a $20,000 pay raise. When the retirement plan was offered, the HR director asked him if he wanted to “max out the match.” Of course he did. The phrase made the action seem inherently prudent and responsible. In this company’s particular case, they had a Safe Harbor match. The company would contribute 100% of what he contributed up to 3% and then 50% of what he contributed on the next 2%. He would contribute 5%, and they would contribute a total of 4%. Seems like a lot, right?
But is it?
No, it’s not. Even with the company helping him out via the matching dollars, assuming an inflation adjusted rate of return of 4%, he and his wife would end up with just $530,000 for retirement in today’s dollars. A widely accepted withdrawal rate assumption of 4% means that they would only be able to “safely” withdraw $21,000 per year. Even with Social Security they would have difficulty maintaining their lifestyle.
What a wasted moment of opportunity. He was getting a pay increase of 33%, more than enough to allow him to get to the “right” savings rate. What if he and his spouse did a little homework and spent an hour or so with an online retirement calculator (see our recommended ones below)? They would have probably figured out that their savings rate should be 15% at that point to get on track for retirement, leaving 18% lifestyle increase to enjoy. Between the 15% and the 4% Safe Harbor match, over time with the same assumptions, their wealth could potentially reach $1.7 million in today’s dollars with an annual withdrawal of $68,000. That amount with Social Security would be enough for them to reasonably maintain their lifestyle throughout retirement.
HIGH EARNER: DETERMINING YOUR SAVINGS RATE
The crew that we think is most at risk of inadvertently under-saving for retirement are the high earners. We have observed a set of conditions that set up high earners to fail to save (enough). First, for physicians making $400,000, the amount they pay in taxes, alone, is often more than other folks might have made in annual salary. So, the first mind trick is the sheer volume of dollars they are dealing with. They might save “a lot” and feel like it is enough just because it is more money than they have ever dealt with (like those tax dollars).
Second, lifestyle creep is real. I do an exercise with residents and med students that is jaw dropping. We group people together in small teams to make lifestyle decisions from college saving to private school to how much home or car to buy. Through the exercise, even though the groups largely made the cheapest decisions, they inevitably run out of money. As Paula Pant says famously in her podcast, Afford Anything, “You can afford anything but not everything.”
The problem with physicians is their wealth comes so suddenly and, again, the money seems so enormous that they get the perception they can buy everything. How many times have people actually said to me, “I make a lot of money. I don’t want to think about how I spend it.” Well, fine. But then you better spend a LOT of time figuring out how to save first (and then stay out of credit card debt).
Unlike most American workers who can pick a savings rate that fits squarely within their retirement plan, set it, forget it, and wake up rich and ready to retire, folks who make a lot of money have it more complicated. Back to our original example. Someone making $400,000 saving so much money, wow, $22,500 PER YEAR, is, well, undersaving. Take $22,500 as a percentage of $400,000, and you quickly realize they are saving a little less than 6% of their pay. Do you know how many docs are probably doing this?
Not to harp on physicians, but let’s be real. They don’t start making their salary until they are in their mid-30s, so between the need to save more money because they make more money (since Social Security will have less impact on their wealth than people who make less money) they actually have to save even more because they are getting a later start.
At the age of 35, someone making a lot of money and nothing saved would need to save about 25% of income to barely slide into age 65 retirement home base. Yikes. What were they saving before? Less than 6%.
Ouch.
Now, what if we are talking about a surgeon or a physician who doesn’t want to sign up to have to work until 65? What if they wanted to retire closer to 55? They would need to save around 40%. To get the right to not have to work until 65.
WHEN TO COMMIT TO YOUR SAVINGS RATE
When should this decision be thought through, agonized over, calculated? Should it be 5 years into the new job, after the car and home are purchased? After you sign up for private school? Funny, that is when a lot of folks do it. Saving is relegated to an afterthought. It’s as if it should be a line-item in a list of equally important decisions.
I think you can see now that if you are a modest earner, make that decision first, before all other decisions. Get the money out of site, out of mind, before lifestyle creep, and you will never feel the dull pain of a lifestyle adjustment.
For high earners, make the savings decision first, before all other decisions. Otherwise, you might sentence yourself to feeling the intense pain of massive lifestyle reductions later on or, rather, the pain of not being able to retire, at least not on your own terms.
I challenge you to spend a couple hours on the topic of how much you should save to meet your unique retirement goal. If you are married, it’s critical that you and your spouse do this together. You can use a compilation of calculators to help you figure this out. My best advice is to not consider any matching contributions in your savings calculation. There are some exceptions. For instance, a local hospital has a 100% savings match up to 10%. Something that significant could probably add to your core savings rate. For instance, in that case, if I was saving 12%, I might consider the hospital’s match into my own savings rate as an additional 5% (splitting the difference).
Below are links to three popular retirement calculators:
Vanguard Retirement Income Calculator