The More We Make, the Tougher It Becomes to Retire

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In this final quarter of the year, I had the opportunity to run retirement plans on quite a few 401(k) plan participants. Whenever possible, I enjoy sitting one-on-one with employees to help them understand and formulate a retirement scenario.

One would think, the less you make the harder it is to retire, but I have found just the opposite to be true. It becomes harder to retire when our income is greater because Social Security replaces less of our income as a percentage.

Let’s review some Social Security basics:

  1. 6.2% is deducted from your pay, matched by your employer, and sent to the government to fund Social Security. That’s 12.4% of your wages in total, up to a maximum wage of $118,500 after which no Social Security tax is deducted.
  2. Your Social Security benefit at retirement is calculated by taking your lifetime earnings (up to each years maximum allowable earnings), indexing for inflation and converting to a monthly amount called your average indexed monthly earnings (AIME).
  3. Your AIME is then reduced against the following progressive formula:
    • 90% of the first $856
    • 32% from $857 to $5,157
    • 15% over $5,157

I know; sounds complicated, but it’s the government what do you expect? Here are three examples to help demonstrate my point:

  1. Bill is age 35, makes $48,000 per year, and plans to retire at age 67. My software projects in today’s dollars he will receive about $2,430 per month in Social Security. That’s roughly 60% of his current income.
  2. Debbie, also age 35, makes $125,000 per year. If she retires at 67, her Social Security is projected to be $4,043 per month, or 40% of her current income.
  3. Gerald is a high wage earner, making around $300,000 per year so he can count on only 16% of his income being replaced by Social Security in retirement, or $4,117 per month in today’s dollars.

In each case, retirement savings will be needed to augment Social Security for a comfortable retirement. As a general rule, we want want our retirement income to be at least 85% of our pre-retirement wages. Let’s assume our examples are just now, at age 35, getting started on retirement savings. How much will they need to save per month to make up the difference between Social Security and 85% of their current income?

  1. Bill will need to contribute at least $355 per month towards his retirement savings plan to meet his goal. That’s 9% of pay and fairly close to the 10% general rule for savings most planners recommend.
  2. Debbie needs to save at least $1,760 of her income, which is a hefty 17% of pay. That’s much higher from a percentage point than most would expect.
  3. Gerald has a huge gap to fill if he wants to live in a similar fashion to his current lifestyle when retired. My software calculates his required monthly contributions towards retirement will need to be at least $6,268 per month, or one-fourth of his paycheck. Ouch!

I have been running retirement plans for over twenty years, and the results still surprise me. With full knowledge, we can adjust our spending to support higher retirement deferral rates as our income increases, but this is rarely the case. Most of us use higher wages to increase our standard of living, but fail to take the necessary steps required to sustain that higher standard in retirement.

The best thing we can do is run a retirement scenario. If you are unsure about how much to save towards retirement, I am happy to help. You may schedule a time to visit with me, either in person or via computer and phone. With some basic information, I can help you determine where you stand and what actions to take. Click here to schedule a complementary time for us to talk.