This Friday's Q&A comes from a thread on Sermo, a physician-only forum.
Question:
I just read an article called Secrets of the 401K Millionaires that says the median 401K balance is $60,000 and only 0.2% of all contributors have topped the $1m mark (2% of age over 55).
The article says the goal for retirement should be to replace 75-80% of one's salary, which means even if I reach the $1 Million mark my income will be no more than $50,000 a year (5% per year withdrawal) plus perhaps $30,000 in Social Security, giving me a total of $80,000 at age 66.
Man, this is depressing. I do not ever see my 401K ever getting to a point of replacing even 40% of my present income the way things are going. Are other physicians comfortable with the rate of growth of their retirement funds in respect to being able to replace 75-80% of present income?
Answer:
I'm comfortable with the rate of growth of my 401K investments. My plan calls for 5% growth after inflation, and I'm just shy of that over the last 8-9 years since I got out of medical school and started investing.
The reason most docs have tiny 401Ks isn't that they've had rotten returns (although that is part of it for many), but rather that they don't contribute enough to it. $17K a year toward retirement isn't going to cut it for most docs. You need to be saving ~20% of your income every year from residency graduation to retirement. 15% at the least.
However, you may be pleased to realize you won't need nearly as much as you think you will. I ran the numbers once and figured I would need something around 30% of my pre-retirement income, not the 70-80% rule of thumb many advisors throw out there. Take away mortgage payments, taxes, child-related expenses, health/disability/life insurance premiums and retirement savings (especially if you save a lot like I do) and you may be surprised how little you actually need to retire on.
You should also keep in mind when reading these surveys, that they take the data from a 401K provider such as Fidelity, and don't take into account other assets that people have, such as old 401Ks, IRAs, taxable accounts, real estate investments, pensions etc. You get to take your retirement income from all that, not just your current 401K. So the data, while bad, isn't as bad as it appears at first.
I don’t know for sure, but I’m willing to be part of the 75-80% of present income number is Becaise they assume most people will still be carrying a mortgage. It seems as though having a mortgage is part of “normal everyday finances.” However, it is also typically the largest monthly expense. I also plan to have no mortgage by the time I retire which allows for a lower post retirement income as you have mentioned.
Crushed by auto correct on that one. Sorry.
Question about the 20% rule: should you save 20% of the ideal income you’d be comfortable living with at the present time, or 20% of your actual income? In my situation, my fixed and discretionary living expenses are a small fraction of what I actually make, and I could live pretty much the same way I do now on about half my salary. So would 20% of half my salary be sufficient for a comfortable retirement? Obviously saving more is the way to go, but I wonder if this approach would be a good minimum amount to shoot for.
My dad has been a dentist 35 years. his 401k balance is also sub 1Mil
but it represents less than 20% of his total assets when you take into account real estate, other accounts, etc.
He’s put very little time into his investment accounts because by his own admission he “sucks” at investing and can’t take the swings.
whereas he has great talents with real estate and other land and what not… and those assets have been nothing short of golden for him.
I’m the opposite, I have 80% of my assets in accounts that have money somehow invested in stocks or other invest-able things like gold (through ETFs) or even real estate (through REITs).
I’m competent with evaluating securities so that’s where i put my money.
But at the same time it’s also been pretty frustrating sometimes to invest given that since i started working in ’01 we’ve had a bear market and a generational crash.
Given that at 35 I have over 300K in the 401 system I definitely expect to be north of 1Mil by 55, but I also live on less than 1/2 of my assets and even with the idea of taking more trips and filling more leisure time, I fully expect not to need 80%.
I personally invest in real estate for cash flow. The cash flow can replace my income and I never have to touch the equity (I can just let it continue to grow). When I die, my children will get the real estate on a stepped up basis. You can even invest this way in self-directed retirement accounts.
My guideline for the typical doctor (and you can decide if you’re typical or not) is 20% of your current salary. That doesn’t mean 20% has to go into a 401K or even the securities markets. If you prefer to invest in real estate, that’s a viable way to reach a comfortable retirement. But it is much more like a second job than buying a few index funds.
I agree that real estate is like a second job if you are an active investor. The only upside I see to being an active investor is if your spouse can qualify for the Real Estate Professional Status from the IRS. Otherwise, why have the headaches? I’d rather invest as a passive investor and get my cash-flow tax free via accelerated depreciation. This also avoids the new 3.8% health care tax on investment profits, because even though I get an actual profit, I get a paper loss. They don’t tax the 3.8% on losses.
I find useful and support the rules of thumb for what you can or should be saving from current income. (20% for docs is good guidance).
What I don’t think is particularly useful is retirement target guidelines based on income at the time of retirement. I think estimates of EXPENSES at retirement is the metric to start with. For example, my husband and I are close to 50 years old; in the last few years our combined salaries have gone from ~$250K to ~$350K does that mean that we now need to generate 80% of $350K per year to retire? I don’t think so. We still spend about the same as we used to, we just save more and pay a lot more in taxes. The calculation is also misleading for those whose income goes down relative to their expenses in later years.
I think a much better approach is to look at what you are actually spending and adjust for foreseen increases and decreases. Then give yourself a cushion that can be used if necessary or maybe passed on to the next generation.
Using a % of your preretirement income is a lazy guide and not very accurate for most people due to fluctuations in income and expenses now and during retirement. A better “rule of thumb” is to estimate your yearly expenses in retirement (no mortgage or childcare expense, more healthcare expenses) and multiple that number by 25-30 years. That is a much better estimate of your “magic number” than any percentage would be.
I agree that estimating expenses is more accurate, but can be difficult to do when you are far from retirement.