How Much Should I Save For Retirement?
Calculating retirement savings goals is not a perfect equation, given the uncertainty about future income, lifespan, portfolio returns, and spending needs throughout retirement. Therefore, a one-size-fits-all savings rate does not exist. Instead, we help clients set savings goals based on the available information and make adjustments as more data becomes apparent.
Current Age and Longevity
When you start saving is a significant variable in successful retirement outcomes. Even at low contribution rates or low income, savers who start early can put fewer dollars away but with more retirement funds at the end of their career due to the magic of compounding interest. The later you start saving, the more money you will need to save to reach the same goal.
How long you will live is also a factor. For example, if you plan on funding a 30-year retirement, from ages 65 to 95, what happens if you live until 110? Currently, the odds are slim (1 in 100,000) that that will happen, but aging research is currently underway and could prolong the lives of today's workers well beyond their 100th birthdays.
Finding Your Replacement Rate
The first step to determining an appropriate saving rate is to estimate your replacement rate. Your spending in retirement will probably range between 70-90% of your spending while working. The three main reasons households spend less than 100% of preretirement income are:
- Likely a lower income tax rate in retirement
- Saving for retirement is no longer required
- Expenses are lower due to commuting costs, dry cleaning, dining out, etc.
The more you spend (or save) in these three categories during your working years, the less income you will need in retirement. However, keep in mind that other expenditures like travel and medical expenses can be higher.
Choosing The Right Investment
Most 401(k) plans (95% of Vanguard plans as of 2020) offer target-date funds, which automatically rebalance and reduce the percent of equity exposure, thereby reducing risk and volatility as participants get closer to retirement. These funds have grown so much in popularity that according to the How America Saves 2022 preview, 56% of Vanguard 401(k) participants invest in just a single target-date fund, compared to just 27% of participants in 2012. However, check the expense ratios before investing in one of these funds, as high fees will erode returns. In addition, while an average S&P fund's long-term average annualized return ranges from 8-10%, a target-date portfolio is not invested 100% in the stock market. Therefore, a long-term investor can expect returns in those funds to average somewhere between 5-8%.
Putting It All Together
Maggie (age 30) is a computer programmer earning $80,000 per year. She wants to replace 80% of her income with retirement savings and Social Security and retire at age 65. She plans to spend $64,000 in today's dollars to last for her 30-year retirement.
Lisa (age 35) is a veterinarian and earns $80,000 per year. She plans to work for another 30 years and wants to replace 80% of her income with retirement savings and Social Security to spend $64,000 per year during her 30-year retirement.
Bart (age 40) invested in a start-up that went bankrupt and is now starting his career and saving over again, but he still wants to retire at age 65. As a salesman, his income (salary and commission) is $80,000. Assuming he also intends to replace 80% of his income with retirement savings and Social Security, how much will he need to start saving this month to spend $64,000 per year in today's dollars and make it last for his 30-year retirement?
If they each have $0 saved today and invest in a fund with an average market return,* using this calculator, Maggie, Lisa, and Bart determine how much they should consider saving to reach their goals. Maggie needs to save $808 per month, Lisa needs to save $1,050, and Bart, starting ten years later than Maggie, will need to save about $1,416 per month. If he gets a 3% match from his employer's retirement plan, he will want to withhold at least 18% of his salary.
If you're closer to retirement than unsure if your retirement Maggie, Lisa, or Bart, want to feel more certain about your ability to afford to retire, the team at Hurlow Wealth Management is here to help. For over two decades, we have helped clients find clarity, feel confident, and achieve comfort in retirement. Schedule a FREE consultation today.
For an introduction to "Income Planning In Retirement," be sure to click the link below to watch our recorded webinar from April 20, 2022.