Working Longer for Retirement

August 12th, 2009 by Potato

Certainly, the math is in its favor: every extra year worked means a bigger nest egg PLUS one fewer year of retirement that needs funding.

There have been lots of stories in the media over the last year or so about people having to postpone retirement because of the effects of the stock market crash on their nest egg (indeed, my dad was briefly afraid he was going to have to come out of retirement, sell the cottage, sell the house, or all three). JC makes an interesting point above: working longer has the double effect of letting you postpone touching your nest egg as well as building it up bigger.

However, I just wanted to run some very simple numbers to show that this is not a very good backup plan. I mean, if you have to, you have to, but just look at what I’m getting at:

Let’s say that you wait until you turn 40 to get your act in gear, your salary has pretty much plateaued, and you start saving 20% of your salary per year until you turn 65, when you plan to retire. Simple math says that you have 0.20(salary) * 25 years = 5 times your salary as your nest egg, assuming that there’s no compounding going on. Compounding at just 3% per year (real return) and you’d have a decent 7.3 times your salary to work with — using the 4% withdrawal rule of thumb gives you about 30% of your working salary to retire on. Not great, but you’ll probably survive, and this is being quite conservative.

Now let’s say that just before you take the golden watch, the market crashes by 30%, and your nest egg is now left at 5.1 times your salary. How much longer would you have to work to get back up to ~7 times your salary? If you keep saving at a 20% rate, and you can’t rely on a bounce in the market (i.e.: no further compounding) — whether that’s because you got scared and sold out, or because you’re just scared enough to not factor it into your plans — then simple math shows that you’re looking at a good 10 additional years of work. True, the real-life situation wouldn’t be that bleak: you wouldn’t need to recover all the way back to what you would have needed to retire at 65, and additionally you could probably manage to save more than 20%/year by cutting back on your spending; saving 50% of your income would mean you’d only need to work an additional ~3-4 years.

Still, that’s a pretty long time to delay your long-planned retirement, and as JC points out, you might not be able to keep it up. So to make sure you don’t get stuck in that situation it’s probably better to plan ahead: include a margin of safety in what you figure your nest egg should be, maybe even plan to keep working for one or two years beyond what you have to just to make sure you have that cushion — after all, if the meltdown came after you’d already retired, it would be that much harder to get back to work. Starting your savings just three years earlier would increase that nest-egg to 8.6 times your salary before the market crash, and if your portfolio crashed 30% you’d still have 6 times your salary, or an extra four and a half years worth of savings thanks to compounding, and that of course gets magnified if you have a greater return than the conservative 3% I arbitrarily picked here.


One Response to “Working Longer for Retirement”

  1. Ben Says:

    Regardless of how you look at it, I still think it sucks that people have to work until their 65 before they can retire. Retirement should be at 40, latest!