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The Center for Economic and Policy Research recently revealed some startling news. The average American has little more than three years of retirement income saved up. This means that many Americans will either find themselves in poverty or will have to keep working for the rest of their lives.
On the other side of the coin, there are those who have saved a huge amount of money for their retirements. However, is it possible to save too much money for retirement? This article takes a look at this issue.
Think About Your Retirement Obligations
The media has jumped on America’s back with the idea that we have to save, save, and keep saving. Retirement is expensive and you do need an income, but you also have to consider your household expenses.
With the average age of retirement in the U.S. being 62, the reality is that so many people will already have come to terms with the many obligations of living life. Unless you happen to have a 30-year mortgage, chances are you will own your home. Hopefully, your children will have already left the nest too.
You can also limit the amount of insurance you need and you no longer have to worry about daily expenses like commuting to and from work.
This can cause your required income levels to fall each year. You want to enjoy your retirement, of course, but the majority will see their financial requirements drop. Never judge your retirement needs on your current needs.
The Issue of Taxable Income
Your retirement fund can be withdrawn at any time, but if you withdraw everything you will pay a huge amount to do it. Retirement income is taxable and you do have to worry about the amount you take out every year. Take out too much at once and you will hit the higher tax brackets.
Nevertheless, if you save too much you will have to withdraw it in larger amounts because you may reach a situation where you find yourself unable to actually use the money. Unless you can guarantee living until you hit 100, much of your income may go to waste.
What About Inflation?
Inflation is another aspect you have to take into account when considering whether you can save too much. Every year inflation will reduce the value of your retirement income. At the very least, you have to add about 5% to your retirement fund every year just to keep it at the same level.
There are no guarantees that inflation will remain low forever and there have been historical periods where inflation has hit the heights of 10%. Imagine if you had a retirement fund of $100,000, which is relatively modest. You would need to add $10,000 in one year simply to make sure it doesn’t lose value.
The way you account for this is by saving more than you actually need during the years where inflation is low and savings interest rates are high.
How Much is Too Much?
An easy way of managing this is to take your annualized costs and multiply it by 25. Just before retirement, the average annualized expenses may be around $30,000, assuming the kids are out on their own and you no longer have to worry about paying off a mortgage.
Your costs will only go down as you continue to get older. They may even decrease to as low as $20,000. Simply multiply the higher number by 25. This will indicate that you need about $750,000. However, this isn’t taking into account social security, which could reduce your expenses to about a third of this.
This means you may need about $250,000 to safely retire at the average age of 62. This is only a minimum, though. It doesn’t take into account the fact that you may have outstanding expenses, second homes, and other bills.
So Can You Save Too Much?
Technically, yes you can save too much. You have to balance the pros and cons of saving more now and enjoying yourself more now. This all comes down to personal preference and how much peace of mind you want. You may decide that you have no desire to live on the edge all the time and this is perfectly okay.
Speak to a financial advisor and assume you are going to follow a conservative career path. It’s always best to imagine that you are in the worst case scenario, than to assume you are going to have a glittering career with a huge $300,000 per year salary by the time you retire.
Take into account which investments you are going to make. Riskier investments should require more of an investment fund to work with. You should balance your riskier investments with more conservative ones. For example, if you invest in stocks you may want to balance things out with an ETF or a government bond.
Author: Jeff Gitlen