Can You Save Too Much for Retirement?

Episode 295 – Is it possible to save too much for retirement? Some have argued that the answer is yes, but with caveats.

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Transcript of Podcast Episode 295

Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode, is it possible to save too much for retirement?

Many of us have been taught that we should accumulate as much money as possible towards our retirement, the belief being that when the time comes to retire, too many people have to cut back on their lifestyle because they didn’t save enough when they had the chance. But how much is too much?

It is certainly true that if you start saving for retirement early, max out your 401(k), get an employer match and invest wisely, you could have a significant amount of money, before taxes, when you decide to walk away from your job.

But in a recent article in Financial Advisor magazine, Allison Schrager, a senior fellow at the Manhattan Institute, argues that maxing out your 401(k) is not the right decision for everyone, especially when you’re young and likely in your lowest earning years.[1]

Schrager’s point is that you could easily overextend yourself if you fully fund your 401(k). This could result in maxing out your credit cards to meet your monthly expenses, maybe even forcing you to resort to getting an expensive payday loan. Either of these could be so costly as to overtake any extra benefits you may have gotten from the 401(k). She even goes so far as to claim that for some people, it’s not worth it to fully fund your 401(k), even if it means foregoing a generous employer match.

Schrager also highlights a Gallup Poll from 2023 where an overwhelming majority of existing retirees—77 percent—say they expect to have enough money to live comfortably. The point seems to be that while it’s better to have more money in retirement, sometimes there may just be better things to do with your money in the interim.

And according to a recent study, many retirees, even those with sufficient funds to enjoy it, still end up underspending and sacrificing their quality of life in their later years.[3] A recent study by J.P. Morgan Asset Management argues that many affluent retirees can afford to spend more than they are currently spending, and that they are unnecessarily afraid that they will eventually run out of money.[4]

Then there is the issue of income taxes. Many experts believe that future tax brackets will eventually be higher than they are today. If that does in fact happen, it could minimize the advantages of a 401(k) or IRA, because you were in a lower bracket when you took the deduction than you were when you had to pay the tax.

But Schrager and others fail to mention one critical point. Whether it’s in a retirement account or not, don’t underestimate the power of starting early. Albert Einstein was alleged to have said that compound interest is “the most powerful force in the universe.”[5] The earlier you start saving—as long as you don’t cripple your lifestyle or create other unnecessary expenses—the better off you will be in the long run. 

Here’s a simple example of the power of compound interest. Let’s say you start saving at age 25, and you put in $5,000 per year to an account that earns 7 percent after taxes. After 10 years, you stop investing and leave the account untouched until you reach age 65.

Now let’s assume your twin sister does something similar. She also invests $5,000 per year into an account that earns 7 percent after taxes. But she doesn’t start until age 35. She knows she’s behind, so unlike you, she doesn’t stop. She keeps putting in $5,000 per year for a full 30 years until she reaches age 65.

So, you put in $5,000 per year for 10 years. She put in $5,000 per year for 30 years. She just started 10 years later.  In the end, who has more money?

Believe it or not, you do, even though she invested three times as much. By getting ahead early, you built up a head start and she doesn’t catch up. At age 65, you have $602,070, while she has $546,091.

So, saving whatever amount you can comfortably afford seems to be the answer, and the sooner the better. The tough part is balancing your retirement and other savings goals with your ongoing expenses.

[1] Schrager, Allison. “Yes, Clients Can Save Too Much For Retirement.” Financial Advisor. https://www.fa-mag.com/news/yes–you-can-save-too-much-for-retirement-78828.html?section=68 (accessed Aug. 6, 2024).

[2] Schrager, Allison. “Yes, Clients Can Save Too Much For Retirement.” Financial Advisor. https://www.fa-mag.com/news/yes–you-can-save-too-much-for-retirement-78828.html?section=68 (accessed Aug. 6, 2024).

[3] Manganaro, John. “Is This Outcome Worse Than Going Broke in Retirement?” Think Advisor. https://www.thinkadvisor.com/2024/07/03/is-this-outcome-worse-than-running-short-in-retirement/  (accessed Aug. 6, 2024).

[4] Manganaro, John. “Spending Down 401(k), IRA Principal ‘Shouldn’t Be Shameful’: Strategist.” Think Advisor. https://www.thinkadvisor.com/2023/03/07/spending-down-401k-ira-principal-shouldnt-be-shameful-strategist/ (accessed Aug. 8, 2024).

[5] Roth, Allan. “Compound Interest – The Most Powerful Force in the Universe?” CBS News. https://www.cbsnews.com/news/compound-interest-the-most-powerful-force-in-the-universe/ (accessed Aug. 9, 2024).

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