I’ll just come out and say it – I don’t like rules of thumb. Financial rules of thumb are often viewed as the only way to way to make financial decisions. They are said so often that people start accepting them as gospel. I’ve heard people say things like, “You have to save 15 percent of your salary” and “You’re crazy if you don’t put money into a Roth IRA.” These rules of thumb could be solid advice for some, and they could be wildly inappropriate for others; it totally depends on who is listening. No two people have the same financial life, so here’s why I throw rules of thumb out completely when talking to clients.
Over the years I’ve heard different rules of thumb when it comes to how much you need to save for retirement. When I first started in the industry that number was 10 percent of your pre-tax income, nowadays a lot of people agree that number is closer to 15 percent. I think we all can agree that more is better, but I never understood where the hard and fast numbers came from. There may be many years during your life where 15 percent may be impossible, perhaps the years where you are paying for childcare or investing in your business and then there may be many years where you’re able to save above and beyond that 15 percent. There are so many ways to set yourself up for a successful retirement and maybe for the masses 15 percent is a good number to shoot for, but it’s not the only number to live by.
The Roth Debate
Roth dollars can be a useful addition to your retirement assets, whether you save into a Roth IRA or take advantage of the Roth option in your 401(k) at work, having those tax-free dollars available to you in retirement will give you more options. By paying the tax on your contributions now, you are guaranteeing that you’ll be able to take tax free distributions once you hit 59½. But how can you guarantee that you’ll be in higher tax bracket when you start withdrawing? In short, you can’t. So, who is to say that contributing to a Traditional IRA/401(k) and taking the deduction now isn’t the best option? In that scenario you are guaranteeing that you receive the tax benefit now and delay paying taxes until you start withdrawing in the future. So, the question becomes do you take the potential benefit in the future or take guaranteed benefit now?
Since none of us know where tax law will be in 20 or 30 years, none of us can say with complete precision that our choice of retirement account today will save us the most in taxes over our lifetime. Heck, the Roth IRA wasn’t even created until 1997, just 23 short years ago. In another 23 years I’m certain we’ll be having a different conversation about the next rule of thumb for retirement savings.
The 15 percent savings rule and Roth example are just two “rules” on very long list that exist in the financial world. Others that come to mind include; waiting until age 70 to file for social security, consolidating your student loans, only withdrawing 4% of your account balance in retirement, I could go on and on. The bottom line is that everyone’s situation is unique because everyone’s life is unique.
Crafting a plan guided by blanket generalizations and rules of thumb may help you reach your goals, or it may not, there’s no way to know for sure. Every person and every family we work with is different and that’s why having a customized financial plan is paramount.