The question of how much money you need for a comfortable retirement is an ancient one. That’s not really true; the concept of retirement is a thoroughly modern invention. Before the industrial revolution people worked until they died of injury or old age. Fortunately for us we no longer have to look forward to dying at our workbenches or in the fields without ever having the opportunity to enjoy the fruits of our labors. However, retirement is a fact of modern life that comes with a host of questions that we have to answer long before our retirement is in sight.
Chief among those questions is how much do I need in my 401(k) to retire comfortably. To answer that question we have to understand how we got to where we are now, and what we should expect when we are ready to retire.
The Beginning of the End
The concept of modern retirement, including the traditional retirement age of 65 was the brainchild of the German Chancellor Otto Von Bismarck in 1889. Bismarck was battling German Marxists for the support of working Germans and devised a system in which he promised to provide an old-age pension for those who are “disabled from work by age”. The original retirement age of 70 was changed to 65 in 1916 and has pretty much remained there ever since.
The United States adopted its own government sponsored retirement system in 1935 with the creation of Social Security. The Social Security Administration’s reasoning for 65 as the age of retirement is a little more involved and includes factors such as the few state pensions that were provided had 65 or 70 as their starting point.
More importantly was the fact that 65 was old enough, given life expectancies at the time, to make the system manageable and self-sustaining with only modest levels of taxation. In 1935 age 65 was the beginning of the end of life and social security was intended to make it easier.
The End of the Beginning
Retirement has evolved over time to become a more active time of life rather than, pardon my pun, a retiring one. Retirement is now viewed as more of an end of the beginning of our lives rather than a beginning of our end. That shift in mindset from sitting around waiting for death to enjoying expanded free time is what drives the need for additional sources of retirement income.
The Employee Benefit Research Institute study on the Expenditure Patterns of Older Americans shows that as we age our expenses decline. Using 65 as their benchmark they found that household expenses drop by 19 percent by age 75 and 34 percent by age 85. The study also found that people over 50 spend between 40-45 percent of their budget on home and home related items. The bottom line is that by the time we retire our expenses are down between 20 and 40 percent which is why expert opinions about how much of our pre-retirement income we need varies from 60 – 80 percent.
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The Big Picture
Is one million dollars enough? If when you retire you have a household income of $100,000 and you use the 80 percent income benchmark as your goal you will need $80,000 a year to maintain your lifestyle. Assuming your 401(k) savings grow at 8% you can expect to have $80,000 a year in interest income without having to touch your principal.
What if your household income at retirement is $200,000 and you only have a million stashed away? Are you really stuck with half of what you will need to retire comfortably? No, a study by a group within the National Institutes of Health, NIH, found that roughly 80 percent of seniors owned their own homes and of those roughly 55 percent owned them free and clear and the majority of the remainder had very little mortgage and equity debt remaining.
A mortgage free home can be a source of income from a reverse mortgage which can be added to your retirement income bottom line. Social security, pensions and other annuities also contribute to your retirement income bottom line. So when calculating the amount you need in your 401(k) it is important to consider the big picture of your finances which includes all of your available assets.
The Bottom Line
The non answer, answer is to have as much as you can in your 401(k) but not to rely exclusively on it for retirement. Contribute as much as possible and follow the rule of thumb that says; when you employer matches your contribution take advantage and throw in at least the amount you need to in order to obtain the maximum matching contribution.
Your retirement plan should include more than your 401(k) for several reasons first of which is volatility. Imagine you turned 65 and retired a month before the markets crashed in 2008 and all you were counting on for income was your 401(k). Now wipe the sweat off your brow and relax you would have regained most of those losses by now and you’ve learned a valuable lesson about putting all your eggs in one basket.
Diversify your retirement savings plan as much as possible, including doing your best to pay off or at least pay down your home mortgage. When it comes to your 401(k) save as much as you can while still contributing to other sources of retirement income including annuities, pension funds (where applicable), life insurance and other investments.
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