You’ll Need More Capital for Retirement!

Posted on September 20, 2011 by Bill Faiferlick

The magic number that so many people have fixated on for their retirement nest egg seems to have been stuck at the $1,000,000.00 level for as long as I can remember. Popular financial gurus continue to promote the concept that $1 million is sufficient assets to have available to live on comfortably throughout retirement.

Unfortunately, there are some serious underlying misconceptions to these calculations. When calculating this figure, most people include their house in their net worth calculation. Homes generally account for a large portion of a person’s net worth and since we all need somewhere to live, using housing as part of the net worth nest egg understates the funds available to live on. The popularity of reverse mortgages validates the fact that retirees are having to access the capital in their homes to maintain their life-styles and don’t have sufficient assets saved.
Most people assume that they will be in a lower tax bracket in retirement; however, according to a National Center for Policy Analysis study, this isn’t necessarily true. The marginal tax rate for seniors who work can reach upwards of 63 percent. “The Social Security benefits tax inflicts some of the highest marginal tax rates in the federal tax code. Although nominally a tax on Social Security benefits, it is really a tax on other retirement income. Because of the benefits tax, the retirement savings of the vast majority of current and future retirees are much less valuable.”- (NCPA)
Example how taxes are calculated:
Once you start receiving Social Security, the claw backs or incremental increases in taxation take a substantial leap. For single individuals, the threshold is at $25,000 and for married couples it’s at $34,000. Once you exceed your respective income threshold by even $.01, $.50 cents of every dollar is taxed including one half of your Social Security benefits until you reach the next tier. The second tier starts at $34,000 for single individuals and $44,000 for married couples. Income above these amounts is taxed at 85%. The effective tax rate for the first tier is approximately 42% while for anyone in the second tier tax rate, it is approximately 52%.
As a rule of thumb, 70% to 80% of pre-retirement income has been used to determine income needed in retirement. Most people believe that their spending in retirement will be less than pre-retirement; however, more than half of retirees said they actually spent the same or more according to a EBRI 2008 Retirement Confidence Survey.
For high income earners, because your tax bill won’t necessarily decrease in large part due to how they calculate tax on Social Security and other sources of income you’ll need higher replacement incomes to maintain current standard of living.
Another factor that erodes retirement capital is the insidious effect of inflation which is more detrimental than taxes because it affects everyone at all income levels. Read: The Power of Inflation to Erode Capital
It is often daunting to realize the total dollar accumulation needed to maintain a certain lifestyle. The graph below identifies how much money will need to be accumulated at the onset of retirement to maintain either a $100,000 or $200,000 per year income.
Figure 1- Charles Gramp – Enrolled Actuary
Retirement Calculators are great initial forecasting tool. Here are some popular calculators: