$1 million question: How much is enough for retirement?
February 16, 2016 12:30 AM
CEO Robert Fragasso
By Tim Grant / Pittsburgh Post-Gazette
One of the most frequently asked yet difficult to answer questions in financial planning comes down to investors wanting to know how much money they need to save to comfortably retire.
Maybe a cool $1 million could be the magic number. Some people will need more. Others may have no problem living out their golden years with much less stashed away.
There’s no one size fits all. Retirees fortunate enough to have a pension don’t need to save as much as someone who doesn’t. The same goes for retirees who’ll be living in a house that’s paid for as opposed to those still saddled with a mortgage.
Robert Fragasso, chairman and CEO of Fragasso Financial Advisors, Downtown, said people don’t necessarily need $1 million to retire. It all depends on the standard of living you desire when your working days are done.
“The last thing you want to do is run out of money before you run out of breath,” Mr. Fragasso said.
To answer the question of how much savings a person who plans to retire at age 65 needs to accumulate for an annual income of either $50,000, $75,000 or $100,000 that will last until age 90, the Fragasso firm recently crunched the numbers.
The advisers factored in an estimated average monthly Social Security benefit for a couple at $2,212 a month with a cost of living adjustment of 2.6 percent per year. They also assumed a rate of return on invested savings of 6.5 percent a year with inflation estimated at 3.5 percent each year.
They found that a person who wants a retirement income of $50,000 a year for the rest of his or her life would need a lump sum of about $500,000. For an annual income of $75,000 the person would need about $1 million saved; and savings of $1.5 million for an annual income of $100,000 combined with Social Security.
“These numbers are based on retirement at age 65,” Mr. Fragasso said. “Now somebody may want to retire at age 60. Then the amount they need to save is going to be bigger because it’s no longer 25 years. It’s 30 years.”
Pension vs. 401(k)
The most prevalent form of retirement saving today is the 401(k) retirement system — a voluntary workplace saving plan that has by and large replaced company pensions as the dominate means of funding retirement — combined with Social Security.
But critics of the 401(k) system say most Americans are terrible investors. People don’t save enough in their plans. And 401(k)s have been a disastrous replacement for pensions.
The Washington, D.C.-based Employee Benefit Research Institute recently set out to answer the question of whether a company pension plan or a 401(k) plan is likely to result in a successful retirement. Researchers found the answer to that question depends on the person’s salary level and the amount of pre-retirement income they want to replace.
It seems the 401(k) plan disproportionately benefits higher income earners because they benefit most from the tax deferral.
Focusing on employees who are eligible for participation in retirement plans for at least 30 years, EBRI found that a final-average pension benefit plan with an accrual rate of 1.5 percent is more likely to provide successful outcomes for lower-income workers when the pension income is combined with expected Social Security benefits.
As income increases, a 401(k) plan has a higher probability of producing a successful outcome than a pension plan when success is defined as a real replacement of more than 60 percent of pre-retirement income.
Thomas J. Mackell Jr., former chairman of the Richmond Federal Reserve Bank, said low economic growth is hampering investors’ ability to earn high rates of return on their investments. He predicts overall U.S. economic growth will probably hover around 2 percent “if we are lucky.”
Mr. Mackell, who also is author of the book “When the Good Pensions Go Away,” does not believe the 401(k) system is working out as intended. He said in 1978, 80 percent of the private sector had pension plans. Today, that number is down to 14 percent.
“The average individual in America, because of financial illiteracy, doesn’t know the difference between a stock or a bond,” he said, adding that the 401(k) system is “a crisis waiting to happen. It’s not ‘will it happen?’ But ‘when.’ ”
A fact of life
Mr. Fragasso, however, said pensions are not sustainable, which is why companies are getting in trouble with them and municipalities are grossly underfunded. He said 401(k)s are a fact of life, and they can work in the employee’s benefit if done the right way.
Having enough money to spend in retirement is part of the challenge, Mr. Fragasso said. The other part is being prepared for unknown factors, such has having an adult child move back home after a divorce with children of their own; having a major health problem that isn’t fully covered; or paying for home care assistance.
“You may have extra expenses you didn’t have during your working career, such as healthcare expenses,” he said. “But you can’t plan if you don’t know that. That’s why we build the extra margin in there. Part of our exercise is we’ll put one of the couple, husband or wife, in a nursing home for three years — which is the average stay — to see what that will do to their numbers.
“Can you self-fund? If you can’t, maybe we need to find the right kind of insurance for that. It’s a complete process. We have to evaluate everything.”
Tim Grant: email@example.com or 412-263-1591.
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