Saving For Retirement

saving rate, saving for retirement

How much should you save for retirement? This is the most frequent question I’m asked by my clients. To answer, I’ll go through the following three questions:

  1. What will your living expenses be during retirement?
  2. How much should you save each paycheck?
  3. Are you on track?

1. What will be your living expenses in retirement?

A simple approach is to assume your living expenses won’t change too much. Yes, there will be some differences — commuting expenses will go down, trips to the grandchildren will go up, etc. — but they’ll roughly cancel out.

With this approach, we can back into an estimate. I’ll start by assuming you’re spending all your income except for 15% that you’re contributing to your retirement account. Also, I’ll assume that another ~8% of your paycheck goes to FICA payroll taxes. That leaves 77% of your gross income being spent on your living expenses and income taxes. If you’re saving more or less than 15%, adjust for that.

You may be wondering about your future income taxes. If you’re saving in a pre-tax retirement account, you’ll pay income tax on the future distributions so you’ll continue to incur this expense. If you’re saving in a Roth retirement account, you’ll free up some spending as you won’t be paying tax on these future distributions and thus you won’t be spending quite as high a percentage in retirement.

However, using 77% of your gross income as your living expenses is a good place to start. For most people, Social Security will replace less than half of that amount so you’ll need to come up with the rest from your savings.

2. How much should you save each paycheck?

The future is uncertain so the answer is imprecise. To complicate things further, your savings rate depends on many factors. Consider these:

  • Women need to save more because you have a longer life expectancy. Also, women may opt out of the workforce to have and raise children and if so, it means fewer years of paying into Social Security and contributing to your 401K.
  • Higher income earners need to save more because higher incomes receive proportionally less from their Social Security benefit.
  • As I already indicated, pre-tax retirement accounts are not worth as much as a Roth because when you withdraw the funds, you will owe taxes.
  • Life expectancy and retirement age are more intuitive. The longer your retirement lasts, the more funds you’ll need.

With those caveats and assuming you save continually throughout your working lifetime, here’s about how much you should save based on the age at which you begin:

Note that these savings rates include any employer match. And, if you have a pension, you can save less.

If you wait until your forties to begin saving, your retirement goals become more challenging, but are still achievable. You’ll need to reduce your current spending and you may need to work more years before beginning retirement.

3. Are you on track with your retirement savings?

This table answers that question:

To orient you around this table:

  • If you’re 30 and your income is $40,000, you should have $20,000 saved to be on track.
  • If you’re 40 and your income is $60,000, your target is between $120,000 and $180,000 in retirement savings.
  • If you’re 67 and retiring with a previous income of $100,000, you should have between $700,000 and $1,000,000 saved to maintain your pre-retirement standard of living.

Why the ranges and not a precise number? It’s the factors that I listed earlier — everyone’s situation is different.

What if you’re not on track right now?

Anytime is a good time to begin to save for retirement. The longer you put it off, the steeper the hill you’ll have to climb.

If you’re behind and want to maintain your standard of living in retirement, you’ll need to do a combination of spending less (so you can save more) and working more years. Those two changes have big positive effects on your retirement security and can get you back on track. By doing so, you will have:

  • more years to save
  • reduced your ongoing living expenses
  • delayed when you claim Social Security
  • fewer years in retirement to support yourself

Lastly, what is the most effective way to save?

Paying yourself first through payroll deductions is the most effective way to save for retirement (or any other purpose). You can read more here.

I also wrote about developing healthy spending and saving habits here.

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