The only thing worse than saving too little is saving too much. Most people who oversave do so at a stiff price in terms of the lifestyle they enjoy. Forgoing travel and nice meals to wind up with a modestly larger estate for heirs is a lousy trade.
Lawrence Kotlikoff, a Boston University economics professor, was among the first to begin raising this red flag. He recognizes that the vast majority of the population is undersaving. The U.S. has one of the lowest savings rates in the developed world, and fewer than one in five retirees has as much as $250,000. Those who diligently save in a 401(k) plan, on the other hand, are doing much better—and along with some others may be overdoing it.
He blames the retirement industry for spooking people into saving too much and shortchanging their daily lifestyle. From his blog:
Around 1.5 million Americans will retire each year through 2025, according to the LIMRA Secure Retirement Institute. More than half of preretirees expect to live less comfortably than they had planned. Granted, a small portion of that is due to scrimping and saving—but if you suspect you are in that crowd, here are some ways you can avoid compromising your lifestyle unnecessarily:
Don’t plan for perfection. Most advisers and savings models rely on Monte Carlo simulations to estimate how long your money will last under various scenarios. You want to end up with a plan that gives you an 80% to 90% chance of not outliving your money. Reaching for, say, 97% certainty gets expensive in terms of the money you must save and may leave you cheaping out for no reason.
Writes Christine Fahlund, senior financial planner for T. Rowe Price: “If you are acknowledging that between 10% and 20% of the time, if you use this strategy, that you might run out in advance, now you are in a good place because you are not leaving too much money on the table.” You want to use that money to enjoy retirement, knowing you can always adjust along the way.
Lock in longevity insurance. An increasingly popular strategy is to use a portion of your savings to purchase a deferred fixed annuity, known as longevity insurance. If you spend $200,000 on this insurance at 65, you can begin collecting around $5,000 a month for the rest of your life at age 85. This provides absolute certainty for how long the rest of your savings must last. There are other considerations like emergency funds and potential healthcare costs. But if you have those bases covered, you can go broke throwing an 85th birthday party.
Stop saving at 60 Saving in small increments over three or four decades is smart because compounding works magic in the later years. But any money you put away past the age of 60 will have little time to grow if you retire at, say, 67. Putting away $5,000 a year for seven years, or a total of $35,000, would result in just $44,200 with a 6% average annual return. Is the $9,200 gain over that span worth the all the cruises you passed up?
Delay Social Security Every year you delay Social Security between ages 62 and 70 results in a certain benefit that is 8% higher. In today’s low rate environment, that’s the best deal around and basically means that if you are in good health and do not need the income you can spend more freely in your 60s knowing the added benefit will pay for some of it. Your kids will make their own money. Don’t play it so safe that you fail to enjoy your retirement years.