The More You Make, the More You Need

March 25, 2015

One of the strange ironies of life is it always seems the more money you make, the more money you need. This is especially true when you think about your retirement plans. As you progress along your career path, your salary will generally increase with annual wage increases and extra increments for experience and additional skills and education. Following a life cycle path, your highest earning years of your career are often near the end of the 30 to 40 years you spend working. Unfortunately, you want your retirement income to support you at the income level you finish your career at -- not the average of what you earned over entire working career.

What is wealth?

You save a little every year and hope to build up a nest egg big enough to support yourself in retirement. The savings you have that can be converted into future income flows are what economists consider wealth. income to wealthThis can be savings in a bank, retirement plans, equity in your home, or ownership of a business or some other significant asset. Every time you put something aside for the future, you are building wealth. You are creating a store of value that you can use to generate a retirement income.

A recent study by the Center for Retirement Research at Boston College showed Americans have followed a fairly stable pattern of accumulating wealth over their working lives. Starting from a very meager base, wealth accumulates each year. Regular contributions to retirement plans, building up equity in homes, and acquiring other long lived assets builds wealth that can provide years of income in retirement. Generally, by the time Americans reach their mid-sixties, their wealth totals three to five times their annual income.

Declining rates of wealth to income

The concern voiced by the Center for Retirement Research is the ratio of wealth to income has been declining recently, especially in the most recent Federal Reserve survey of consumer finances. This is especially concerning for several reasons.

First of all, life spans are increasing. Your wealth will have to support you through more years of retirement as you live longer. Second, heath costs are increasing rapidly. Living a longer life also increases the odds you will face higher medical costs in retirement. Third, the level of interest rates has declined so the amount of income your savings can generate has fallen sharply. Finally, the amount of income you will receive from Social Security has declined due to an older age requirement to receive full benefits and the taxation of benefits for higher income individuals. Taken all together, you will need more wealth as a percentage of your final income to maintain your lifestyle.

Closing thoughts

So the old adage holds true, the more you make the more you will need. The income you will need in retirement is a portion of your final income -- not your average income over your life. Savings every year and generating accumulated wealth will build a nest egg to support you in retirement. Generally, American’s have maintained a constant ratio of accumulated wealth to income as their working lives have progressed but going forward, they may need more to maintain themselves in a longer and more costly retirement.