Saving Too Much for Retirement?

Conventional wisdom says that you can't save enough for retirement. Considering that Americans are living longer and are rarely given guaranteed pensions from employers, it certainly makes sense to save sufficient funds to ensure a long, comfortable retirement. But how much should you be saving towards your retirement each year? And is it possible that you're saving too much of your income towards retirement?

In crunching through the numbers, it turns out that determining the right amount to save for retirement is more of an art than a science. These calculations are left in the hands of workers who may or may not have the tools necessary to complete such an exercise. Financial planners can help with the analysis, but the tools that they use often have a huge "factor of safety," which may lead you to believe that your financial situation is much worse than it actually is.

To illustrate, let's consider the Retirement Planning Worksheet that is often used by financial planners to aid their clients in determining the right amount to save for the future. As with any analysis, this worksheet requires assumptions and estimates regarding future events. However, these assumptions may lead to a gross overstatement of how much you'll need to save for retirement. For example, the analysis assumes an inflation of 4.5% and a 7.5% return on investment. While this does allow for a conservative analysis which permits users to consider a worst case scenario, it does not adequately reflect the historical annual inflation rate of 3% and average rate of return which ranges between 8-10%. It may not seem that these small differences would be an issue, but when compounded over 25 years, the differences are huge. Using the financial planner's assumptions, a 35 year old that currently has $50,000 saved towards retirement would project that these savings would be worth $379,000 at age 60. If instead you assumed that the inflation rate was in-line with the historical value of 3% and assumed a conservative rate of return on your investments of 8%, this same $50,000 would instead be worth $466,000 at age 60. Using the more conservative assumptions would mean that you could be understating your current retirement savings by more than 20%.

No one knows what the future will hold as far as the world's investment markets and economy go. Worst case scenarios can and should be considered when thinking about your future retirement plans. When planning your retirement, make sure that you understand what assumptions are being used to determine how much you should be saving for the future.