You've saved, saved, and saved some more, and now, you’re nearing retirement and have amassed a fortune in your 401(K) and IRA accounts. Nonetheless, you keep on going, right? You keep on saving until you retire. After all, that’s the golden rule of finance.
Maybe not.
Sometimes, all that diligent saving can actually cause more financial harm than good, particularly when you’ve already hit your retirement savings targets.
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What could go wrong with saving too much for retirement, you may wonder? From taxes to death, read on to find out.
1. Saving too much can trigger a taxable event
Saving for retirement isn’t bad, but putting all your money in a traditional 401(k) or IRA is a different story, and you can blame taxes for that.
When you withdraw money from a 401(k) or IRA in retirement, you pay taxes. Depending on your income bracket, it may be a little or a lot.
Once you reach age 73, it gets a little more interesting because that’s when RMDs kick in. You have to take them every year — the IRS wants to get paid — and they are treated as ordinary income and are taxed as such. Depending on how much you have in your 401(k) or IRA, it could trigger a big taxable event.
Dan Sudit, founding partner at Crewe Advisors, pointed to one client in his 80s who, along with his wife, saved $14 million in an IRA and was required to take about $600,000 in RMDs per year. That, coupled with Social Security and capital gains from other investments, pushed their annual income to over $1 million, even though their spending was a fraction of that.
”They’re paying top-tier taxes and their Medicare contributions are significant, simply because they did what they were told to do, save for retirement,” said Sudit.
Luckily, Sudit’s clients are philanthropically inclined and have been making qualified charitable contributions, which offset some of their tax burden.
What you can do
A little planning goes a long way.
Sudit has another client who has $7 million in her traditional 401(k). To avoid paying taxes on all of her RMDs, Sudit converted $2.5 million of her 401(k) into a Roth IRA, which doesn’t have RMDs, in a low tax year before turning 73.
To learn more about how a Roth conversion works, check out our guide here.
2. Saving too much can stop you from living
Saving can be intoxicating. Watching the balance grow and compound can make you want to save more. It could also cause you to think twice before you spend, if it means you can funnel more money into your retirement savings account or draw down less when you are in retirement.
But continuing to save could be harmful if it means you miss out on life. “If you saved enough to sustain your lifestyle in retirement, then you have the opportunity to spend,” said Chelse Stevens, vice president & financial consultant at Fidelity Investments. Think of it as more of a permission to spend if you are still reluctant.
What you can do
How you spend money makes a difference. Some people take lavish trips. Some remodel their homes to make them more retirement-friendly. For others, spending could be as simple as dining out more often.
Maybe you'd like to assist your family financially, such as helping your grandchildren with college costs or adult children with the down payment for a home. Or you might want to take the extended family on a once-in-a-lifetime cruise or other vacation. The idea is to create memories while you're healthy and well instead of continuing to save indefinitely. If you wait too long to pursue experiences, you risk losing the chance to have them entirely.
Not sure how to spend all your cash in retirement? Check out our 'Die With Zero' Rule to get some guidance on how.
3. Saving too much means your money might outlive you
There is a high likelihood that many of us will live into our late 80s, but that doesn’t mean we'll spend with abandon til then.
Typically, spending slows as you age, which means that if you keep on saving, your money could outlive you.
Consider this: According to a JPMorgan calculation, a 65-year-old retiring today, who made $300,000 a year, would need to save $2.67 million for 35 years in retirement. You can see how your money can outlive you, depending on how much you have saved.
What you can do
Giving with “warm hands” is one option, says Stevens.
Instead of waiting until you pass to donate to charity, give while you are alive so you can see the impact of your generosity. Wouldn’t it be great to give money to help cure a disease and see that come to fruition, or to feed families in a local community? By donating with "warm hands," you get that chance.
Save in the right place
Continuing to save in a 401(K) or IRA may not be a tax-smart way to go, but that doesn’t mean you can’t save. If it's in your nature, you're going to save no matter what. If that’s the case, it comes down to where and why you're saving that matters.
If you haven’t been giving your health care much thought and have a high-deductible health insurance plan, a Health Savings Account (HSA) may be worth opening. If you were planning to start a new business and need access to capital, saving in a brokerage account may be a more tax advantageous move.
“You can’t save too much," says Stevens. "Things can come up in retirement — Health care and unexpected expenses. It's a matter of saving in the right place."
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