In the last post, Are You Saving Too Much for Retirement? How to Tell if You Are “Retirement Poor,” I discussed how to tell if you have saved up enough for retirement already and how to tell if you need to save more. I also talked about the state of being “retirement poor,” where you are saving up so much for retirement that you don’t have cash for anything else. Saving up enough for retirement is certainly important and a lot of people don’t do so and end up home-bound in their remaining years because they don’t have the money needed to do the things they thought they would in retirement. Many also end up in nursing homes who could stay at home with nursing help if they had the money.
You can overdue saving for retirement, however. There is a lot of life before retirement. There is also the satisfaction of having enough saved in readily available assets to support yourself indefinitely without a job. If you have $10 M in a retirement fund when you are fifty years old, but little saved outside of that fund, you still won’t be able to do things like pay cash to upgrade vehicles, pay tuition for your children without putting a strain on the budget, or break away from a job you don’t like and spend some time finding one you enjoy more. You are very wealthy but the cash you have is locked away in the retirement fund. You need to strike a good balance between saving and investing for retirement and building up resources that you can tap as needed before you retire.
Most retirement vehicles have maximum contribution limits and many people are tempted to put the maximums away. They may put $5000 into an IRA and also max out a 401k plan because they get a tax break for doing so without really determining if they need to put so much away. Certainly it is nice to keep a lot of the money you make rather than sending it off to the tax man, but there should be a limit. The worse thing would be to save your whole life and never really do anything, waiting for that magical retirement day where you get to travel the world, only to get ill during your last year before retirement and never get to enjoy any of it.
There is also a chance a large retirement account could be taken in the future through taxes or direct confiscation. With so many people not saving anything for retirement and many countries, including the US, eyeing Value Added Taxes and other taxes that would take more money from retirees, it is entirely possible that your fortune may be largely swallowed up by taxes. With Social Security and other retirement programs facing underruns by the mid 2030’s and the government in general reaching unsustainable debt levels, we might also see a “fix” for Social Security that involves taking all of the money people have saved for retirement to shore up the public system or a big levy being placed on withdrawals to support government programs. You might have saved diligently but may be living next door to a family that spent their whole lives living it up on credit and debt who therefore have nothing in retirement. If you have $10M and they have nothing, there will certainly be people who will want to force you to give up a large share of your fortune because you have so much and they have nothing. It doesn’t matter that you both had the opportunity to save and that the other family already got rewarded for their work while you delayed pleasure. In the world of socialist politics, wealth is evil and poverty is saintly.
Instead of squirreling everything away for retirement, it therefore makes sense to just save enough for retirement and then start putting money into taxable assets that still allow wealth to grow tax deferred; in other words, stocks. In this way you will have retirement covered but also be building up the wealth you need to supplement your income while you’re young. By doing so you will: 1) have more financial security and be better able to deal with events that arise; 2) have more freedom in your career, primary school and college choices for children, access to medical care, and other facets of life; 3) eliminate the need for debt, thereby reducing the amount of interest you pay over your lifetime by having the cash needed to make big purchases, and 4) have another source of funds to support you in retirement that will not be encumbered should a tax on retirement distributions be enacted.
A more balanced cash flow plan includes allocations of money for current needs and wants, for retirement, for other known future needs (like college and car replacements), and money to build security and lifestyle. Such a plan might look like the following:
Primary residence mortgage: 25% of net income
Retirement: 15% of net income
College: 3% of net income per child
Large Purchase Fund: 10% of net income
Asset Building: 10% of net income
Living Expenses: The remainder of net income
For example, a family that had a take-home pay of $60,000 per year from their jobs and one child might have the following cash flow plan:
Mortgage: $15,000/year ($1250 per month)
Retirement: $9000 per year ($5000 in an IRA and $4000 in a 401K to get the employer match)
College: $3600 per year ($2000 in an educational IRA and the rest in mutual funds or a state college savings plan)
Large Purchase Fund: $6,000 per year ($500 per month into a broad index mutual fund)
Asset Building: $6,000 per year ($500 per month into index mutual funds with individual stocks added periodically)
Living expenses: $22,200 per year ($1700 per month for living, with $500 for groceries, $400 for clothing, $300 for utilities and gasoline, $300 for insurance and property taxes, $200 for entertainment each month and $1800 each year for vacations).
Note that they are not maxing out retirement plans, but they are putting away plenty to ensure a comfortable retirement, especially if they get another 5% of gross pay or so each year as an employer match. They are also probably not putting enough away for private colleges for their child, but they should be able to make a big dent in college costs for a state school and with increases in their work incomes and paying off their home they’ll be able to support some fo the cost directly.
Note also that this is just the starter cash flow plan. With time the assets in the taxable account will build, increasing income and allowing more to be spent on things like entertainment and vacations. They will also be able to reinvest a portion of the funds, causing their accounts to build even faster. In the next post I’ll take this family and see where they are financially in 10 and 20 years.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.