The Big Error Most Experts Make on Retirement Savings
To Plan Ahead, You Need to Look Forward, Not Backward
The 75 percent to 85 percent rule is based on a false assumption. It implies that you currently spend every dime you make (minus the 15 percent to 20 percent you should save for retirement). But how many people really live this way?
If you already spend a lot less than you earn, following this rule would mean you'd wind up putting aside far too much for retirement. And, while this isn't a bad thing by any means, it prevents you from using that extra money for other things in the present, such as your kids' college funds or a down payment on a house.
%VIRTUAL-article-sponsoredlinks%Smart money management is all about allocating your money so that it works hardest for whatever goals you've set for yourself. Having lopsided goals defeats the purpose.
On the flip side, if you spend a lot more than you earn, following the 75 percent to 85 percent rule won't give you nearly enough to enjoy a comfortable retirement. If you're spending more than you earn today, chances are you've accumulated considerable credit card debt and other loans. Paying that down will take a chunk out of any savings you manage to set aside. Besides, you'll need to seriously reconsider the standard of living you intend to maintain once you hit retirement and are on a fixed income.
What You Should Do Instead
A better strategy is to aim to replace 85 percent to 100 percent of your current expenses. This makes much more sense, for a number of reasons:
- Your current income really has nothing to do with your retirement needs. Rather than artificially basing your savings goal on whatever number your boss has set your salary at, you're saving based on exactly how much you plan to need to live on once you reach retirement. It's less arbitrary and more reality-based.
- Living expenses change over time. This new approach factors in the ways your living expenses will change between now and retirement. You'll probably live pretty much the same way you do now (unless you're one of those over-spenders we touched on, in which case you've got some thinking to do). But you'll be dropping some expenses when you retire (your commute, work clothes, and, one hopes, your mortgage) and adding new ones (golfing, travel, supporting your 26-year-old son who still lives in your basement). You need to plan ahead for these changes.
- Retirement brings on extra expenses. Basing your savings on your current salary doesn't take into account the additional expenses that can arise when you reach retirement age. From caring for aging parents to dealing with the Medicare "doughnut hole" (a gap in Medicare Part D prescription drug coverage), there are certain expenses you'll be forced to handle. You need to be able to provide yourself with a financial cushion should those things come to pass. Only a savings plan based on estimated expenses, not current income, can allow you to do this.
Paula Pant ditched her 9-to-5 job in 2008. She's traveled to 30 countries, owns six rental units and runs a business from her laptop. Her blog, Afford Anything, is a gathering spot for rebels who refuse to say, "I can't afford it." Visit Afford Anything to learn how to shatter limits, quit your job and live life on your own terms.