Don't guess your way to a retirement savings plan

How do you think almost half of all workers estimated the amount of savings they’ll need by the time they retire? If you guessed that they guessed, you’d be guessing right, according to a recent survey conducted by the Transamerica Center for Retirement Studies (TCRS). The survey also found that better methods of estimating this amount included the following:

  • Using a retirement calculator, reported by 9 percent of workers
  • Expected earnings on investments (6 percent)
  • Amount offered by a financial adviser (4 percent)
  • Completing a worksheet or doing a calculation (4 percent)

All told, however, only 23 percent of surveyed workers used those better solutions.

Simply put, guessing is generally a bad idea because most people guess too low. According to data gathered by Catherine Collinson, president of TCRS, workers who used a retirement calculator reported a median needed savings amount of $1 million. But workers who guessed at this amount reported a median needed savings amount of $500,000.

For a quick reality check, $1 million in retirement savings could generate an annual retirement income of $40,000, assuming you use the 4 percent rule to calculate how much you can prudently withdraw from savings each year. In this example, you’d add this amount to your Social Security and other income, and it’s possible you could have enough retirement income to live comfortably.

With $500,000 in retirement savings, you could generate $20,000 in annual retirement income.When added to your Social Security and other income, that amount could fall short of what you’d need.

Here’s another reality check: These retirement income estimates assume you dedicate all of your savings to generating income and that you don’t set aside any for emergencies or medical expenses. Doing so would reduce the retirement income that could be generated for other living expenses. 

For example, according to an analysis by Fidelity Investments, the present value of future medical expenses for a 65-year-old married couple is estimated to be $260,000. This amount includes future Medicare premiums and out-of-pocket expenses such as deductibles and co-payments. 

The Employee Benefit Research Institute (EBRI) provides verification of these amounts. EBRI estimates that if a married couple wanted a 50/50 chance of having enough money to fund medical expenses, they’d need $157,000 in savings. If they want a 90 percent chance of having enough money for medical expenses, they’d need $264,000. Both the Fidelity and EBRI numbers don’t include costs for long-term care, which would increase these numbers.

If you want to improve the odds of achieving a secure retirement, you’ll want a realistic estimate of the savings you’ll need. It might take some time to select a retirement calculator and learn how to properly use it, but it’s a good use of your time. If you’re interesting in finding one, start with your 401(k) plan administrator: Many offer online calculators and phone support for interpreting the results.

If you feel uncomfortable estimating this amount on your own, engage a professional adviser to help you. According to the TCRS study, not many workers do this. The survey found that only 39 percent of workers use an adviser for any purpose, and of these people, 49 percent use an adviser to set retirement savings goals.

Multiplying these numbers together results in less than one in five (19 percent) of workers who ask a retirement adviser to calculate their savings needs.

Many 401(k) plans also offer advice that will include setting retirement savings goals. Look for advisers who are qualified to help with retirement income planning and are compensated to have your best interests at heart.

Many workers have access to the resources they need to help them plan for retirement. But the question is: Do you have the gumption to take action to improve your security?

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.