Are You Saving Too Much for Retirement?

Retirement planning almost always starts with one number: A guesstimate of the percentage of pre-retirement income you're expected to need after you retire. That's called the "replacement rate" and is often pegged by industry experts at around 80 percent of a household's earnings.

For example, a recent paper from the Center for Retirement Research at Boston College titled "How much to save for a secure retirement," relies on that 80 percent figure. "Households with earnings of $50,000 and over needed about 80 percent of pre-retirement earnings to maintain the same level of consumption," writes Alicia Munnell, author of the study.

She goes on to say that high earners need to save extremely high percentages of their income -- as much as 77 percent for the 45-year-old just starting to save for retirement at age 62 -- to produce that 80 percent.

The concept underlying Munnell's paper, and a lot of other retirement planning advice, is that you can figure out how much you need to save once you have a number for that 80 percent replacement rate.

But there's reason to believe that oft-quoted 80 percent figure is wildly on the high side. That, in turn, makes the retirement calculations based upon it also wildly off. And that means if you're trying to save enough money to produce that 80 percent figure, you may be putting away too much, or skimping unnecessarily on the early years of retirement.

Now, some academics are taking aim at that rule of thumb. "It's a sometimes bizarre measure that could have absolutely nothing to do with your standard of living," said Bonnie-Jeanne MacDonald, an actuary who currently holds two fellowships, one at Dalhousie University in Halifax, Nova Scotia, and another with the North American Society of Actuaries.

In a recent paper underwritten by the actuaries group and co-authored with Kevin Moore from Statistics Canada, the Canadian government's official agency, she reported that traditional replacement rate calculations have so many limitations and fallacies that they shouldn't be counted on by workers trying to plan their retirement savings.

"For a financial adviser to say you will need 70 percent or 80 percent of your income, and here's how much you have to save, is not very helpful," MacDonald said in a recent interview.

That has big implications for workers who are now exhorted on a daily basis to save more and more, 'lest they run out of money in retirement. If you really don't need 70 percent or 80 percent of your last paycheck for the rest of your life, you don't have to save enough to produce that figure. And saving too much has its consequences, says MacDonald.

"It's not coming from nowhere; it means you're making big reductions in your standard of living before retirement to make your standard of living higher after retirement," she explains.

Here's how to get a better handle on those projections.

Do your own math. Pre-retirees should try to calculate those discredited rules of thumb and estimate their own retirement needs more specifically. Look at how much you're spending now, and see which costs you think will disappear when you retire, or during your retirement. For example, when will you pay off your mortgage and finish helping your kids pay for college? How much will you save in taxes once you're not working? Add in more for costs, such as health care, that could go up.

Look at the data. True spending patterns suggest your first years of retirement will be your most expensive. Consider these figures from the Bureau of Labor Statistics' consumer expenditure survey for 2010:

The average household headed by someone age 45 to 54 spends 57,788 a year. Those years are typically the highest-earning, highest-spending years. Average expenditures for the 55-to-64 age group (which presumably includes workers as well as early retirees) are $50,900; 88 percent of the expenditures for the younger group. Heads-of-household aged 65 to 75 spent an average of $41,434 in 2010, or about 72 percent of the amount spent during those early prime-earning years. And households headed by those over 75? They only spent an average of $31,529, or 55 percent of their peak spending.

That means that even if you do need 80 percent, or more, in your first years of retirement, you will not need that forever. That changes the savings calculus.

You may be able to front-load your retirement spending. That's most likely what you would do anyway, because people in their first year of retirement often spend extra money on special trips, home repairs and new hobbies.

Another retirement rule of thumb says you should pull out only 4 percent of retirement savings in your first year if you want your money to last 30 years. So, if you've saved $500,000, you could withdraw $20,000, or $1,667 a month. But, if you're willing to curtail spending down the road, you could start with bigger withdrawals early, says Christopher Van Slyke, a money manager in Austin, Texas. He tells some of his newly retired clients they can start by pulling 5.5 percent or 6 percent out of their portfolios for a few years, as long as they understand that that rate isn't sustainable for three decades.

Of course, it may not have to be.