The True Cost of Retirement

As a dentist, your particular retirement plan varies depending upon your career path and spending habits.  Recent research, conducted by David Blanchett, CFA, CFP, Head of Retirement Research at Morningstar Investment Management, was published in his Working Paper dated November 5, 2013.  It suggests that the true cost of retirement may be less for some, and vary more widely from household to household than once thought. Assumptions have long held that the percentage of household earnings needed to maintain a similar standard of living in retirement, also known as the replacement rate, hovers around 70-80{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} of annual pre-retirement income.  But, recent research suggests that the amount truly needed for retirement, although varying significantly household to household, may actually range from 54{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} to over 87{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}.  Therefore, in planning for your retirement, it is important to consider your specific circumstances and spending habits.  Further, your specific employment situation, as an owner or associate dentist, will affect the amount you should save for retirement. 

Actual Consumption and Expenditures Vary

 Collectively, the spending curve of households varies depending upon the level of consumption and the level of funding within the household.  Households with lower levels of consumption and higher funding ratios tend to increase spending at retirement, while households with higher consumption levels and lower funding ratios tend to decrease spending at retirement.  Of course, the actual change in consumption at retirement varies widely for each individual household.  Blanchett’s analysis defined the replacement rate, the percentage of household earnings needed to maintain the pre-retirement standard of living during retirement, as:

The total household income during retirement

divided by

The household income earned pre-retirement.

Assumptions taken into consideration in the analysis included: (i) households ceasing to save for retirement, (ii) households ceasing to pay Medicare and Social Security taxes; (iii) a state tax rate of 4{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}; as well as (iv) the ability of retirees to claim two deductions.

Two trends that seem to hold true despite varying replacement rates include: (i) the relative amount spent on insurance and pensions decreases with age; and (ii) the amount spent on healthcare increases significantly with age. Still, although healthcare expenditures increase with age, medical costs affect retirees differently depending upon Medicare coverage or out-of-pocket expenses, like long-term care financing.

Retirement Planning for Dentists

 Some general steps that should be taken when planning for retirement include: 

  1. Meeting with a financial advisor to help plan your portfolio;
  2. Saving early (consider the effect of compounding on the value of an annuity/your savings);
  3. Opening a 401(k) or IRA;
  4. Ensuring that you have a well-diversified portfolio to spread risk out over a number of investments;
  5. Putting off retiring and continuing to work, which will give your portfolio more time to increase in value;
  6. Creating a budget and sticking to it, both before and especially after retirement; and
  7. Purchasing long-term care insurance or investing in a Health Savings Account. 

Conclusion and Recommendations

 All factors considered, the amount needed for retirement varies significantly and may actually be 20{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} less than predicted by traditional models.  But, this does not mean that one should put off saving for retirement.  The earlier you begin saving, the safer you will be when retirement rolls around.  You should also consider your particular career path with respect to planning for retirement, as your worth will be influenced by whether you are an associate dentist or practice owner. By following the above suggestions and by investing the time and resources into meeting with a financial planner with experience in helping dentists plan for retirement,  you can gain a more accurate perspective on the true cost of your retirement.  Having a more accurate perspective on the true cost of retirement will help prepare you for the retirement that you deserve.

Nardone Limited Comment: To the extent that you need a referral for a good financial advisor, please contact us.