Most of the headlines you’re likely to see in regards to saving for retirement are about how people are not saving enough for retirement. Men, women, high income earners and minimum wage earners, they seem to have something in common when it comes to saving for retirement, which is, most likely they aren’t saving enough. I definitely believe this to be true and fear for many of my own friends and family and what might await them in retirement. But today I want to examine the flip side of this coin, where I wonder can a person actually save too much for retirement?
There really isn’t a straightforward answer to this as in a simple yes or no, and even if there was, it is likely to widely vary for each individual situation, but lately I’ve actually been wondering about this for myself. There are two reasons that make me worry that I might save too much for retirement. First is due to Required Minimum Distribution (RMD) which is the minimum amount the IRS requires you to withdraw from all your retirement accounts starting age 70.5, which might leave us with a glut of income in our later years, possibly forcing us to pay more in taxes. The second reason is the “opportunity costs” of having saved too much for retirement instead of having enjoyed that money here and now.
After all, every time you save a part of your money for retirement, it is an opportunity cost to you of some kind. You denied yourself a nice dress, eating out at fancy restaurants, upgrading to first class, or maybe even investing in a business venture or new career, whatever it may be that you could be enjoying or using the money now that you deferred for future security or future use. I doubt most people are saving just for savings sake and to watch their money accumulate with no end purpose. They probably save because they want to be financially secure or independent in the future, especially when a weakened body or mind and/or poor health may prevent them from working or because they just no longer want to work anymore at some point in time. But is there a point where you saved so much that the opportunity costs are too high? I think so. I think for myself there’s probably a point where the excess money I’ll have in retirement is too much, especially in light of my belief that I probably would’ve enjoyed spending that money much more now in my 20’s to 60’s than when I’m older, like in my late 60’s to 90’s. I’ve seen it happen with my parents. My dad said when he was my age, he looked forward to buying fancy golf clubs or going on a nice vacation. Now he doesn’t really want to do anything or buy anything, and he’s just as happy watching golf on tv. My mom still wants to travel, but a weaker body prevents her from being able to travel as much as she’d like. I’m not saying all people are like my dad or mom when they get older, but I don’t think I’m alone in believing that I’ll enjoy spending my money more when I’m younger than when I’m older.
How do RMD’s and taxes play into this? Some people, contrary to the masses, are actually quite avid savers. They dutifully sock away 20%, 30% or even more of their income into savings. Read Millionaire Next Door, that whole book is about frugal avid savers. It’s probably as rare as a solar eclipse or having both your children fall asleep at the same time for a nap so that you can also nap, but there are people who can save a disproportionate amount of their income in relation to their spending. Maybe that’s you. You could’ve been diligently maxing out your 401(k)/403(b)/457 since you started working sometime in your 20’s and plan to do so until you retire and/or your company has a very generous match. Maybe you also had access to a SEP-IRA at different times in your life because you ran your own side business or did freelance work, which means you could’ve contributed up to 25% of your earned income or $53,000 (which ever is less) during those years. Add that up along with the power of compounding and some people will end up with quite a hefty little nest egg for themselves in retirement. Coming back around to my situation, I don’t think I’m nearly as avid of a saver like those of the millionaire next door kind (in fact I did their expected household net worth equation [10% X Age X Income = Expected Net Worth] and I wasn’t), but I have been maxing out my 403(b) since I started working at age 27 and putting the max into a Roth IRA yearly since age 30. I actually also receive a small match. Let’s say theoretically I plan on contributing the maximum elective deferral every year including the catch-up contributions starting age 50 til around age 67 (my “retirement” age). Because I can’t predict the years the IRS will increase the contribution limit or by how much, for simplicity sakes I’m going to just assume the current max elective deferral contribution limit of $18,000 for all the years from age 27 to 67, and $6000 catch-up contribution limit for all the years from age 50 to 67. Then, assuming a conservative net 3% return rate (after subtracting 3% for inflation and because the McKinsey study and Vanguard are saying current investors need to resign ourselves to a lower rate of return), I could end up with ~$1.5 million in my 403(b) at age 67. Counting my husband’s 401k, we could as a couple end up with ~$3M in our retirement accounts before taxes, though advisors have projected as much as us accumulating 7 million in our retirement accounts by age 67.
Now, the IRS imposes something called Required Minimum Distribution (RMD) on all your retirement accounts (i.e. 401(k), 403(b), 457, TSP) and IRA, SEP IRA, SIMPLE IRA, when you reach age 70½ (except good ole Roth IRA). RMD is the minimum amount you must withdraw yearly from these accounts starting age 70½ or you’ll have to pay a penalty. RMD’s are calculated based on your account balance and your expected life expectancy, which means your RMD amount actually increases as you age (up to a certain point where the balance is getting significantly lower). Please note, this next part isn’t really going to be an accurate portrayal of the RMD’s that will be required of us, because there’s no such thing as a future RMD calculator just like I can’t predict how the IRS will increase the contribution limits in the future. But just for the purposes of a very simple example, bear with me. I went ahead and plugged in my theoretical future numbers into a current RMD calculator (Schwab’s and Vanguard’s) and saw that my husband and I would would be required to withdraw at least approximately $100,000/year initially in RMD’s. Add to that 50% of our estimated social security income (I choose 50% because current information shows payroll taxes will cover 75% of SS benefits through 2089, but I’m being a bit more conservative in my estimate just in case) that we’ll receive and any rental income (we own one rental property currently and it’s not completely outside the realm of possibilities that we might own another) and/or wages we might be earning since we both hope to work part-time even after reaching 67. I’ll also be retiring with a pension that’s set to replace 60% of my current income and you can see that we could easily be in the same or even higher marginal tax bracket than we are now once RMD’s kick in. This doesn’t even include the Roth IRA accounts we both have or the money we also save in a taxable account (which might not be there but you never know) and the house we’ll probably own with little to no mortgage left.
Obviously this scenario has a ton of assumptions and some major limitations because I can’t predict future increases in the maximum elective deferral limit by the IRS or tax rates or future RMD rates. It’s also quite possible, one of us or both of us could end up in poor health, requiring a lot of money for medical bills or a serious disability that prevents us from working before we hit our planned retirement age. The stock market could tank right before or during our retirement as it did in 2008 or one or both of our children could end up dependent on us even in retirement =X. And then again, I could die tomorrow too.
Between finding out you’re going to outlive your money because you didn’t save enough and having to pay too much in taxes because you have too much saved, I think most people would prefer the latter. Nevertheless, it’s still something to think about because of the opportunity cost situation. Part of life is enjoying the present, the here and now and some of that requires money. I want to carefully balance saving sufficiently for retirement with saving too much for retirement. Unfortunately, there’s no way to predict how much is too much but some of this situation can be mitigated with proper tax planning along the way to and in retirement.
So, what do you think? Can a person save too much for retirement? Do you think you might be one of them? Share with us in the comments below!