Small changes in savings and spending for younger, working clients can have a big effect on a financial plan because increasing savings often means we can reduce the expected spending needed in retirement.
When we set up a financial plan for a new client, often the numbers don’t work well initially. We work to figure out how much the clients may need to spend in retirement, which is often just a shot-in-the-dark guess, especially for younger clients. Quite often, the client will need to increase their savings, sometimes substantially, to make the plan work, and this can be a daunting proposition.
The Reality of Saving for Retirement
In reality, it frequently isn’t that bad. When we create the initial spending goal for a new client, often all we have to go by is their current spending, adjusted for things that change during retirement. We use formulas in our planning software, but an old rule of thumb is that if you don’t have specific spending needs worked out, you can plan on needing around 75% of your current income, adjusted for inflation when you reach retirement to replace your current lifestyle.
Better Than Expected
When we make adjustments, it often works better than clients expect. If you’re basing your retirement spending on what you’re spending now, AND you can begin to reduce what you spend now in order to save for the future, the impact is double. Not only do the resources grow to support that spending, but the expected spending goal can also be lowered to reflect the fact that you have adjusted your budget to allow for more savings. In effect, learning to live on less while working to save enough for retirement works to improve both parts of the equation. If we learn to live on less and save more while we’re younger and working, we won’t revert to a higher need, at least for basic retirement spending, when we get there.
Imagine Fred and Ethyl, who are 40 years old and want to be able to retire in their mid-60s. They are saving about $10,000 per year toward retirement and spending about $100,000 of their net income. For simplicity’s sake, we’ll use the rule of thumb retirement spending target of $75,000 based on their current spending. To make the plan work, Nick calculates that Fred and Ethyl really need to be saving about $20,000 per year.
Fred and Ethyl decide that the goal of retiring on time and replacing their current lifestyle is worth some sacrifice, so they begin saving more. A year later during a review, they sheepishly admit they have only been able to save an additional $5000 by reducing how much they go out to eat and being more mindful of extra spending. However, adjusting the plan for savings and updating the spending goal shows a greater improvement than expected. If they are now spending $95,000 instead of $100,000, we would expect their need in retirement to be $71,250 per year instead of the original $75,000. This in turn reduces the amount of necessary retirement savings. Fred and Ethyl are pleasantly surprised and decide to go home and try to find a way to contribute another $300/month to their retirement plans for the next year, continuing the cycle.
Are You Ready to Review Your Retirement Plan?
This is a simple example. Life, and financial planning, are more complicated, but the main thing to keep in mind is although initial financial planning calls for lifestyle changes that may sound painful, incremental changes can be more powerful than we assume.
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About Shotwell Rutter Baer
Shotwell Rutter Baer is proud to be an independent, fee-only registered investment advisory firm. This means that we are only compensated by our clients for our knowledge and guidance — not from commissions by selling financial products. Our only motivation is to help you achieve financial freedom and peace of mind. By structuring our business this way we believe that many of the conflicts of interest that plague the financial services industry are eliminated. We work for our clients, period.
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Call us at 517-321-4832 for financial and retirement investing advice.