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

As a result, the financial risk — of setting aside enough money and investing those funds to produce a reliable income in the future — has been shifted from employer to individual employees. If it feels like you’re on your own, you are.

To encourage you to get started, the financial services industry has tried to keep retirement planning simple. The typical process starts with an estimate of how much income you’ll need to maintain a “comfortable” standard of living. Most retirement plans rely on what’s known as a “replacement” model — enough to replace 80 percent or more of your income before retirement.

You're then asked to decide how long you expect to live and try to guess how well your investments will do and how high inflation will be after you retire. Plug those numbers into one of many available calculators, and out pops a number — usually a very big number.

That represents the nest egg you need to accumulate by retirement age to generate the annual income you desire. After taking into account how much you have already saved and invested, along with the number of years left before you retire, you’re then instructed how much you need to save each month to reach your target. That's your retirement plan. (For one version of this approach, check out our own retirement calculator.)

But your plan is only as good as three critical assumptions that you have been asked to make: How long you will live; how much you’ll earn on your investments in up and down markets over your lifetime; and your armchair inflation forecast for the next several decades. Even the most gifted economists and financial analysts acknowledge these variables are all but unknowable.

For many prospective retirees, in fact, it’s hard enough predicting what retired life will look like. A generation ago, choices were fairly limited, according to Ron Manheimer, director of the
North Carolina Center for Creative Retirement, which runs workshops for people making the transition to retirement. Some people continued to work as long as they were able, whether because they had to or needed to. Others stopped work and filled their days with leisure, travel or lifelong hobbies. 

“I think what’s happened is that we are now in a time when for many people that sort of black-and-white or static picture is gone,” Manheimer said. “People are exploring different combinations and different degrees of continued work, leisure and volunteering and so on. And that becomes more complicated and more difficult to predict.”

That uncertainty about the course of your retired life — never mind your forecasts for inflation, investment returns, and your own longevity — leads some people to throw up their hands at the idea of realistic planning. Others wind up making assumptions that may be overly conservative, says Kotlikoff, creating nest egg targets that may be bigger than needed.

No matter how modest the target, some people — especially younger workers supporting families — say they can’t afford to fund it. At least not now. But the situation for late-in-life savers isn’t hopeless — far from it, says Kotlikoff. His research suggests that most people don’t start saving for retirement until their late 40s — especially if they’re focused on things like raising kids, buying a house in a neighborhood with good schools, and paying off student loans.

The solution to these retirement planning shortcomings, says Kotlikoff, is a lifetime approach that attempts to smooth out the ups and downs of living standards by better accounting for swings in income, saving and spending throughout life. To help people do the math, Kotlikoff has come up with software package called ESPlanner that sells for $149. (While the math behind it is sophisticated, the user interface is a little clunky.)

ESPlanner includes some of the conventional calculations about saving and investing for long-term spending goals. But instead of assuming you’ll need a fixed income for life when you retire, the software attempts to forecast how your spending will go up — and down — after you stop earning a paycheck.

The effect, for some people, is to reduce the size of the nest egg that a “fixed-income-for life” retirement plan would require, said Kotlikoff.

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