(Today’s post was suggested by my daughter, who keeps an eye on Gen Y financial issues…)

Shortly after Hallowe’en, MSN put up a scary article about Generation Y needing to save (spoken, of course, in a creepy Dr. Evil voice) two million dollars for retirement. And if that’s not frightening enough people, the article also claims that Gen X will need almost as much.  In other words, most of today’s workers need at least that much to retire.

Seriously?!? Where do these scary articles (and numbers) come from?

First, there’s plenty of (not retired) journalists and bloggers trying to make their article’s filing deadline. (He claimed as he typed ever faster, nervously eyeing the clock.) Under that pressure, it’s tempting to spout any statistic as long as it inspires controversy. Truth is preferred but facts are negotiable. It’s even better if the information is sensational instead of boring. “GenY should be OK for retirement” is not a headline. “GenY has to find $2M or keep working!!” is better.

In this case the article’s headline was drawn from a survey of 226 registered investment advisers hired by Scottrade.

Second, did they come up with the numbers to calculate a $2M figure? Well, they really didn’t. They used “average expenses” for GenY and GenX, and then assumed that they’d keep working until “around age 70”. A different study used multiples of average salaries.

I can play sensational deadline-journalism games and pull my numbers out of survey averages, too. But I don’t have to, and neither do you:  we can use real math for your real life.  Is the article even worth reading? Let’s summarize their advice, and then see if it’s useful or worthless:

• Set a worthy goal.
• Take advantage of employer help.
• Control costs.
• Get a Roth IRA or 401(k).
• Maximize Social Security.
• Don’t plan on retiring at 65.
• Don’t get hung up on the number.

What’s a “worthy goal”? This part of the article’s advice is worthless. For starters, the goal is not an “average expense” or a multiple of your income. It’s not even a percentage of your salary or your annual expenses. Thumbrules don’t work for everyone. There’s really only one way to figure it out, it’s different for every individual, and it doesn’t inspire scary headlines.

Here it is: track your expenses, make an annual budget based on your values and those expenses, and then save at least 25x that budget. When you get to that number then stay invested in a diversified portfolio of equities and other assets. Withdraw 4% the first year of retirement. Raise each following year’s withdrawals for inflation. If you want to spend more occasionally then you probably can, but you’ll need to do more analysis and maybe have an annuity provide some of your income in case the markets turn against you.  Of course if you’re earning a military retirement check then the answer is almost always “Yes!“, but even if you only complete one enlistment then you can still make the math work for you.

Employer help is the match of your 401(k) contributions: “free money” in your retirement account. Good advice. Some of your salary contributions to your retirement 401(k) account are matched by your employer’s funds, up to a certain maximum. Although many 401(k) programs are burdened with high expenses, extra fees, and poor investment choices– the employer match makes it worth the effort. If you’re in the military you don’t have an employer match (only the Thrift Savings Plan) but you should still try to maximize your contributions every year. The earlier you contribute the funds, the longer they’ll be able to compound before you need to use them. The more you put in (up to the max employer match) then the more you’ll have compounding.

Control costs. You might not have much control over your earnings, but you can certainly reduce your expenses. The less you pay to manage your investments then the more money you’ll be able to invest. Good advice. Financial planner (and military veteran) Rick Ferri puts numbers on this concept in a “worst case” study of a retirement as the markets peaked in 2000.  (Thanks to reader Ted for suggesting the link!) Ferri’s analysis shows the erosive effects of high expenses and adviser’s fees. Another example is the typical investment adviser’s annual 1% fee. When you’re withdrawing 4% every year from a retirement portfolio, do you really want to hand over a quarter of that withdrawal to an adviser?

Another way to control costs is to invest more of your savings in tax-free accounts like a Roth IRA or a Roth 401(k). Good advice. You won’t get a tax deduction but you won’t pay taxes on the earnings, either. Today’s taxes probably won’t go much lower but future taxes may be much higher, and a Roth will avoid that taxation. You should still get the maximum employer’s match to your 401(k), and you should still try to maximize your TSP contribution when you’re on active duty, but after those hurdles are met you should try to maximize your Roth savings. The more you can save, the sooner you’ll reach financial independence. It typically takes 10-20 years of military & civilian employment, but a few can do it in less time.

Social Security is a great example of a retirement annuity that usually kicks in no earlier than age 62. If you maximize your earnings for 35 years and delay Social Security withdrawals until you’re 70 years old then you’ll extract the maximum benefit from the system. If you’re not interested in working for 35 years or waiting until age 70, then keep track of your estimated benefits and factor them into your savings goal. If you retire straight out of a military active-duty career then you’ll only have 20 years of Social Security earnings. However, if you’ve saved aggressively then you may already be financially independent, even though your Social Security benefits would be lower. Not good advice, but not worthless. If you don’t save then this is society’s safety net.

Should you plan to keep working until age 65? Should you work even longer? Worthless advice— work that long only if you want to! If you design your spending plan around your values, save aggressively and control your investment expenses, then you’ll be financially independent as early as your 40s. Of course a 20-year military retirement makes that even easier, but that’s just one way to maximize the math. Low expenses and a high savings rate are another approach, along with part-time employment or side income from other sources (like a website or a rental property). I hope you find a career that’s fascinating, fulfilling, and lets you live the life you want to have– but when you’re financially independent then you can work on your terms.

Ironically the article concludes with its best advice: don’t get hung up on the number. $2M can be very discouraging if you don’t assess the context behind it, and your number will probably be a lot lower.

Is that number even possible, let alone realistic? How much money can one human be expected to earn during their life? Well, my daughter suggested this article, so let’s look at her salary. When she’s commissioned she’ll start pulling down a righteous O-1 paycheck. The military will raise her pay every year, but if they want to retain her then they’ll make those raises keep up with inflation. If we assume that military pay keeps up with inflation then we can use the Department of Defense 2011 pay tables for 20 years of income.  Even during a drawdown, if she stays on active duty for 20 years and promotes to O-4 she’ll earn nearly $1.35 million. In addition she’ll earn a minimum of another $300K in subsistence and housing allowances. Add in sea pay(!), specialty pay, and bonus pay and she’ll earn $2M before she turns 42 years old. If she promotes to O-5 then it happens even faster.

You can earn $2M during your life even if you’re not a military officer. You don’t even have to retire from the military if you’re willing to pursue a civilian bridge career. But if you want to be financially independent in your 40s then you’ll have to decide what’s important to your lifestyle and save as much money as you can. You’re earning it. Now you have to figure out how to keep it!

Related articles:
Is the 4% withdrawal rate really safe?
How many years does it take to become financially independent?

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