The Retirement Challenge Facing High Salaried Workers
I want to share with you a scenario that I’ve encountered several times when doing retirement planning for high salaried individuals, especially legal and medical professionals. All too often I see these clients not begin saving for retirement early enough and not putting enough away when larger paychecks start rolling in.
How Saving for Retirement Should Work
To best illustrate the issue let’s first take a look at a traditional professional white collar worker who saves enough for retirement. Let’s call them Jane Techie. Jane went to a public college and majored in information technology. She graduated in four years and has $25,000 in student debt (about the average for a public college graduate). Out of school, she gets her first job making $66,000 per year (about the average for an information technology worker). She’s busy paying down student loans so she only puts away 5% in her company 401(k). Her employer also matches 5%. After 10 years when her student loans are paid down she follows conventional wisdom and starts putting away 10% of her salary or $6,600 per year again with a $3300 employer match.
Let’s assume Jane earns 8% on average in her portfolio and gets a 3.5% raise every year. If Jane works for 43 years (retiring at around age 65) she’ll have an investment portfolio worth about $1,200,000 in today dollars, assuming cost of living inflation of 2.85%, when she retires. The financial planning industry is constantly debating what the safe withdraw rate from a portfolio is to avoid the chance of running out of money. Estimates range from 3% to 5% so for our discussion we’ll use that range rather than any exact estimate. If she doesn’t want to run out of money she can withdraw about $37,000 to $60,000 every year. She’ll also be earning a bit over $17,500 in Social Security depending on when she files. All together she’s looking at in income of $54,500 to $67,500 in retirement.
Jane will be able to keep up whatever life style she is currently living when she retires. She’ll be able to come close to her pre-retirement income of $66,000 to $86,500.
The Challenge for High Income Earners
Now let’s look at the case of a high income professional, Dr. John Doe. He goes to college and then on to medical school and finally four years of residency. He accumulates a pretty hefty chunk of student debt and isn’t really able to save much while in residency. The result is that he only begins saving for retirement when he’s in his early 30s and only has about 35 years until retirement. He gets a job out of medical school paying $225,000 per year. Let’s say each year he gets a 5% raise so by the end of his career he’s making almost $400,000 adjusted for a 2.85% inflation rate (we’ll adjust all figures we present using this inflation rate). For the first decade, he’s busy paying back the prodigious student he racked up in medical school and is only contributing $20,000 per year to retirement including any company or partnership matches and increasing at 5% just like his salary. After ten years, he realizes he’s pretty far behind and starts socking away $40,000 per year, again including any matches and increasing at 5% just like his salary.
The result is John has a cool $3M saved up for retirement assuming 8% returns. That might seem like it should be plenty. It’s enough for $90,000 to $150,000 in retirement income plus social security. The problem is that it’s pretty far below what his $400,000 salary was when he retired. For many clients their expenses drop close to retirement. For example a mortgage might be paid off or they might finally be done paying for their children’s college expenses. However other significant expenses usually remain. They may live in a wealthy neighborhood with high property taxes or they may want to travel more. It’s difficult for many people who are used to living a life style that $300,000 or $400,000 per year provides to suddenly shift gears and start living on half that amount. Sure, it’s possible and they can still live comfortably but they may not want to do it. That’s why making sure you have a solid financial plan early is so important.
Summary
The point of this article is to emphasize how important it is for individual with high salaries, especially those that spend a large chunk of time in post secondary education such as medical school or law school, to start saving a lot for retirement as soon as they possibly can. Putting away $50,000, $75,000, or even $100,000 the last few years won’t cut it. In our example, adding just an extra $5,000 per year right after residency ($25,000 instead of $20,000) adds an extra $10,000 to $25,000 annually in retirement income. It’s important to realize that if you want to keep up a certain lifestyle through retirement then you’ll need to be putting away big chunks of income, likely more than you think, as early as possible.