More and more Americans are faced with the challenge and burden to save for their own retirement as pensions continue to fall by the wayside. The trouble is determining how much money you need to amass before you can retire. Answering the question of ‘how much should I save before I retire’ and ‘how much should I have already accumulated to be on track to retire’ prove quite difficult, mainly because there is no one-size-fits-all solution for calculating a person’s needs in retirement. To get the best answer to either of these questions, it takes a tailored and customized calculation and solution that incorporates all facets of a household.
Saving for retirement is not always a priority for most Americans – especially when you are young. When you are a young worker, there are a lot of fixed costs associated with everyday living, such as mortgage payments, car payments, student loan payments, insurance, food and other regular bills. As we age, part of these payments/bills will remain fixed or constant, while others are variable and change throughout the course of life.
Marlena Lee and Massi De Santis, both of Dimensional Fund Advisors, recently published their research titled “How Much Should I Save For Retirement” 1 and it attempts to solve both of these ubiquitous questions. They summarized their findings in their paper, and we will summarize it below.
According to Lee and De Santis’ research, after accounting for both fluctuations in income over a working career and uncertainty of investment returns, if you would like to replace 40% of your income with a 90% probability, you need to save the following percentage(%) of your salary starting at different ages.
|90% Success Probability||Start Saving @ age 25||Start Saving @ age 30||Start Saving @ age 35|
|% of Salary to Save||13.2%||15.4%||19.2%|
For example, if you are currently 25, you should be saving 13.2% of your salary. If you wait until age 30 to start saving for retirement, you need to save 15.4% of your salary. These savings percentages reflect a constant savings rate over your working career depending on the age you start saving at. These savings rates look overwhelming whether you start at 25 or 35, which is why Lee and De Santis came up with an alternative approach to increase savings as salary increases over your career.
|Income Range($, Low-High)||Annual Savings rate needed to replace 40% of your income with a 90% probability of success|
For example, if you are making $65,000 per year, according to the research, you should be saving 11% of your salary or $7,150 per year. The savings percentages in the above table can be applied on a household basis too. For example, if the total household income is $155,000 per year, then the household savings should be 23.7% of total household salary or $36,735 per year. On a household level, this suggested annual savings amount is just about equal to the maximum 401(k) contribution limit for two workers under the age of 50 ($17,500/person in 2013) and less than twice the annual contribution limit for two workers over the age of 50 contributing the maximum to their 401(k) plans ($23,000/person in 2013).
If you work for an employer and they offer a 401(k) plan or another form of a retirement plan, you should take advantage of the retirement plan – regardless of employer matching of employee contributions. If the employer offers a match, there is little reason to not participate and save at least up to the match from the employer. Remember you are responsible for your financial success. If you have a wealth manager, they can help motivate you to save, but you ultimately control your level of savings – and spending.
One technique we often suggest to clients is every time you get a raise, you put the entire raise into your retirement plan. For example, if you are making $63,100, and you are saving 8.32% of your salary ($5,250) you would be behind the target savings rate of 11%. Suppose you get a raise of about 3% to $65,000, and you put the whole raise into your retirement plan ($1,900) a total of $7,150 or 11%, you would be right on target. It is an easy calculation to make with the assistance of your wealth manager.
Am I on track? Effect of Accumulated Assets
In Lee and De Santis’ research, they calculate target asset/income multiples for different ages. The information found in their research is depicted in the table below. This table assumes a 40% replacement rate and a 90% probability of success.
Asset Income Multiple
|Age 35||Age 40||Age 45||Age 50||Age 55||Age 60||Age 65|
|On track if your Asset Level is the following multiple of your salary||1.00||2.38||3.75||5.63||7.50||8.75||10.00|
We took the liberty of interpolating calculating the in between numbers for Age 40, 50, 60 & 65. Ages 35, 45 and 55 were provided by Lee and DeSantis. You can read this table using the following example of a $100,000 salary. If someone, makes $100,000 then they should have accumulated $100,000 at age 35, $375,000 at age 45 and $750,000 at age 55 and $1,000,000 at age 65. Even if you are on track, there could be other opportunities you are missing such as mitigating taxes, creating a tax efficient portfolio and making sure your estate plan is updated.
These are general rules of thumb and your circumstances and situation may be different. For lower salaries, social security should provide a great supplement to retirement savings. For higher individual salaries, savings rates might need to be higher since social security becomes capped.
1-Lee, Marlena and Massi DeSantis. “How Much Should I Save For Retirement.” Dimensional Fund Advisors. June 2013. 16 Oct. 2013. http://www.dfaus.com/pdf/How_Much_Should_I_Save.pdf
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail firstname.lastname@example.org.
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