How big a ‘nest egg’ do you need to retire?

John W. Schoen Senior producer • Profile • E-mail

For millions of Americans, retirement planning is all about accumulating a “nest egg” of savings and investments to generate enough income to pay for a comfortable standard of living after they stop working. The quality of life in your golden years, this line of thinking goes, is determined almost solely by how well you’ve estimated the size of the nest egg you need and how close you get to accumulating it.

But this process, especially as applied by the trillion-dollar financial services industry that many would-be retirees turn to, often raises more questions than it answers — some of which are unknowable. How long will you live? Will stocks and bonds perform as well in the next 25 years as they have in the last 25? And what happens if your retirement coincides with a period of high inflation that takes a big bite out of the spending power of your hard-earned nest egg?

Some contrarians believe that the conventional wisdom — by focusing so heavily on savings and paying less attention to spending patterns in retirement — may cause some people to save more than they really need to.

In some cases, balancing savings and spending means rethinking retirement goals. Because living costs vary so widely from one part of the country to another, for example, many retirees find themselves cutting costs by moving from high-cost locales to more affordable neighborhoods.

Rebecca Hale, 58, of Tucson, Ariz., is an example.  Hale, who is single, says family obligations kept her from stashing savings in her 401(k) until late in life. So she’s counting on pensions, Social Security and the sale of her home to top off her nest egg. She’s set her retirement sights on moving south of the border.

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“I kind of calculated that I wouldn’t have enough to retire in the U.S., and I’ve always been fond of Latin countries,” she said. “I figure that for $4,000 a month I can live like a queen in Mexico.

But you don't have to move to another country to match your spending goals with your retirement savings.

“The traditional methodology is giving very bad advice,” said Lawrence Kotlikoff, an economics professor at Boston University. “The targeting for how much to plan on spending in retirement is being done by people that are trying to sell securities and insurance policies. That right there is a conflict of interest.”

Kotlikoff, who has developed his own methodology (more on that later), argues that for some people, the typical method of shooting for a fixed minimum income for life creates a savings target that is higher than it needs to be. But that suits the financial services industry just fine, he says.

“I’m not suggesting that everyone is oversaving or that we don’t have a saving problem with a lot of the population. We do,” he said. “We also have an oversaving problem with a lot of the population. They’re different people.”

The lucrative business of advising individuals on retirement planning is a relatively new one. Just a generation ago, most workers relied on an old-fashioned “defined benefit” pension plan that promised to pay a monthly check for life after they reach a certain age. Income from savings and investments might pay for “extras” — like a cruise or gifts for the grandchildren — but weren’t needed to cover basic living expenses.

But the pool of people who can expect to retire with a guaranteed monthly check from their employer is rapidly shrinking, an artifact of a bygone era. In 1979, nearly two out of every three U.S. workers participated in a defined benefit plan; by 2005 that number had fallen to one in 10.

Pensions have been largely replaced by “defined contribution” retirement savings plans that rely on employees diverting part of their paychecks, with employers kicking in some matching funds. Participation in these plans has risen from 16 percent of the work force in 1979 to about two-thirds as of 2005. 

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