Over-Saving for Retirement?

Haruki writes in:

I am putting 15% of my salary into my 401(k) which gets a 5% match from my employer. I also contribute the max to my Roth IRA.

I followed up with Haruki and found that his salary is $46,000 per year and he’s twenty seven years old, just for calculation’s sake.

So let’s put all of the math together. Haruki contributes $5,000 a year to his Roth IRA. He also contributes $6,900 to his 401(k) and his employer contributes $2,300 to his 401(k), too. Added together, Haruki’s retirement savings each year is $14,200 – 30.9% of his salary.

I think that’s excessive, and I told Haruki why.

First, saving 31% of your income for retirement will give you an abundance in retirement savings. When you finally retire, even if you step away at the minimum possible age that you can access your retirement savings without penalty, you’ll have more than enough for retirement. For some, this seems like a problem they wish they would have, but having excessive income in retirement means excessive taxes in retirement. In short, if you have a mountain of cash in your 401(k), you’ll be paying more taxes upon withdrawal than you ever would if you were more careful about your life’s financial plan.

Second, when you hit your “number,” you’ll likely be many years short of retirement. If you’re saving this much for the dream of retiring early, you might not wind up happy. When you do hit your “number” – the amount you need to have to live sustainably in retirement – and you’re much younger than your retirement age, you’re stuck. You’ll have all the resources you need, but they’re locked up. Of course, you can use your Roth IRA contributions for a few years, since you can withdraw your contributions without penalty, but it won’t cover you for more than two or three years.

The big reason, though, is that excessive retirement savings takes away from your other life goals. Dropping that 401(k) contribution back to 10% gives you another 5% of your salary – $2,300 pre-tax – to save for other life goals without diminishing the quality of your retirement. Instead, start socking that money away for other goals: a big fat emergency fund, a home down payment, a small business you dream of starting, a vacation, or whatever it is that really makes your life worth living.

Haruki is doing tremendously well – this is not a criticism of his saving habits, which are stellar. If you have the capacity to save more than you actually need for retirement, that’s awesome. It’s not a bad thing.

Instead, take some time to step back from your retirement savings Think through your life goals and make some serious, well-informed decisions. Here’s how.

First, calculate your “number.” In other words, figure up how much you’ll need to live on sustainably in retirement. There are tons of different calculators and calculations out there – your best bet is to use several and trust the one that estimates the largest total amount – then add 10%. CNN’s retirement calculator and MSN’s retirement calculator are both useful places to start, but try running your numbers through every one you come across.

Next, calculate how much you need to put away each year to reach that goal at your target age. Assume a 7% annual return on your investments, which is what Warren Buffett suggests is the long-term trend for stocks. One way to get a bead on this is to tinker with the numbers on retirement calculators – set the annual rate of return to 7% and play around with the annual contributions you would need to make to get to your target number. This will give you a good savings number to shoot for each year.

Once you’re sure that you’re saving enough for retirement at the age you want to retire, target the rest of your savings towards other goals. Save for a home, for a car, or for a small business. Give money to a charity. Our goal is a home in the country with a barn in the back which we want to make as green as possible – we want to shoot for near self-sustainability. We also want to do some serious volunteer work in retirement.

What if extra retirement savings makes you feel more secure? If that’s the case – and you don’t have any other goals you’re strongly pushing towards – then feel free to contribute more towards your retirement savings.

In the end, it’s worth your while to make sure that, if you’re focused on saving, that your savings are helping you truly fulfill your dreams. Good luck!

Trent Hamm

Founder & Columnist

Trent Hamm founded The Simple Dollar in 2006 and still writes a daily column on personal finance. He’s the author of three books published by Simon & Schuster and Financial Times Press, has contributed to Business Insider, US News & World Report, Yahoo Finance, and Lifehacker, and his financial advice has been featured in The New York Times, TIME, Forbes, The Guardian, and elsewhere.