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How Much Money Will You Need for Retirement? More than You Think

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What you don’t know can’t hurt you, according to the old saying. When it comes to retirement planning though, the old saying doesn’t apply.

Most people understand that the sooner they begin planning for retirement, the better. Putting money aside now rather than later means your assets have a longer time to grow. But what many people don’t know is the amount of money they will need to live on in their golden years.

Olivia S. Mitchell, the executive director of Wharton’s Pension Research Council, says people tend to focus on the “accumulation phase” of retirement planning – the years spent working and making decisions on how much to save and what to invest in. Not enough attention is given to how much income is needed after they stop working.

Mitchell suggests that people assume that they will need 100% of their pre-retirement income each year after they retire, which is higher than what most financial planners recommend. While retirees may not need to spend as much on parking or on clothes as they did when they were working, they may decide to travel or take up expensive hobbies. Mitchell says: “If you end up having more than you actually need, you’ll be in better shape.”

Experts at Wharton believe that most people seriously underestimate the possibility of outliving their assets. Even people with high incomes may not be good retirement planners. According to Mitchell: “In some cases, savings shortfalls were worse for people with high earnings – while high income earners are in a position to save a lot, they also tend to spend a lot.”

According to Wharton’s research, many significantly underestimate healthcare costs – particularly costs linked to long-term care and health insurance. Many also don’t focus enough on the risk posed by inflation. A low inflation rate can also erode one’s nest egg over 30 years of retirement.

Perhaps the most neglected facet of retirement planning is longevity risk. “People tend not to think about mortality,” according to Mitchell. “At best, they think about life expectancy but about half of all people live longer than their life expectancy. Women especially can live into their 90s or even reach their 100th birthday.”

Some people buy annuities to address the risk that they may outlive their retirement assets.

When a person buys an annuity, the insurance company guarantees a regular stream of payments over a period of time. Some annuities accumulate assets over the long term and produce a steady income at retirement. Some annuities make payments right away and are typically bought with a lump-sum contribution. Depending on the terms, some payouts are based on a fixed rate of interest, while others fluctuate depending on the performance of the stocks, bonds or other vehicles in which the annuity’s principal is invested in.

While annuities can serve as an important component of a person's overall retirement savings plan, Mitchell stresses that an annuity should be primarily viewed as a form of insurance and not as an investment. "You don't buy an annuity to make money – you buy it to make sure that when you’re 97 years old, you have income coming in."

Source: Knowledge@Wharton. Aug 27, 2003. The original article can be found at http://knowledge.wharton.upenn.edu/article/how-much-money-will-you-need-for-retirement-more-than-you-think/