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Encore
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How Much Do You Have To Save for Retirement?

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Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.”

People often ask how much they have to save for a secure retirement.  The answer depends on a number of factors.

  • Earnings level.  The lower the earnings, the greater the portion provided by Social Security and the lower the individual’s required saving rate.
  • Rate of return.  The higher the rate of return on assets, the lower the required saving rate.
  • Age when saving begins.  The earlier the individual starts saving, the lower the required rate for any given retirement age.
  • Age of retirement.  The later the individual retires, the lower the required rate.

A simple model shows that starting early and working longer are far more effective levers for gaining a secure retirement than earning a higher return. The model takes an 80% replacement rate as the goal, assumes Social Security benefits remain as promised under current law, and assumes people draw down 4% of their wealth each year.  It then calculates the required saving rates for individuals at different earnings levels, at different starting and ending ages, and at different rates of return.

The required saving rates for the medium earner, assuming a rate of return of 4% are presented in Table 1.  Two messages stand out.  First, starting to save at age 25, rather than age 45, cuts the required saving rate by about two thirds.  Second, delaying retirement from age 62 to age 70 also reduces the required saving rate by about two thirds.  As a result, the individual who starts at 25 and retires at 70 needs to save only 7% of earnings, roughly one tenth of the rate required of an individual who starts at 45 and retires at 62 – an impossible 65%.  But note that even that individual who starts at 45 has a plausible 18% required saving rate if he postpones retirement to age 70.

Table 1. Saving Rate Required for a Medium Earner to Attain an 80-Percent Replacement Rate with a 4-Percent Rate of Return

Retire at: Start Saving at:
25 35 45
62 22% 35% 65%
65 15% 24% 41%
67 12% 18% 31%
70 7% 11% 18%

Source: Author’s estimates.

Retiring later is an extremely powerful lever for several reasons.  First, because Social Security monthly benefits are actuarially adjusted, they are over 75% higher at age 70 than age 62.  Second, by postponing retirement people have additional years to contribute to their 401(k) and allow their balances to grow.   Finally, a later retirement age means that people have fewer years to support themselves on their accumulated retirement assets.

Table 2 shows the impact of lower and higher rates of return for individuals who start at age 35.  The 2% return is slightly less than the inflation-adjusted long-run rate of return on intermediate-term government bonds and the 6-percent return is slightly less than the inflation-adjusted long-run rate of return on large cap stocks.  While higher returns require smaller contribution rates, they also come with increased risk.  Even ignoring risk, the required saving differentials are less than those associated with dates for starting to save and the age of retirement. In fact, an individual can offset the impact of a 2% return instead of a 6% return by retiring at 67 instead of 62.

Table 2. Saving Rate Required for a Medium Earner to Attain an 80% Replacement Rate with a Starting Age of 35, by Rate of Return

Retire at: Real Rate of Return
2% 4% 6%
62 46% 35% 26%
65 32% 24% 17%
67 26% 18% 13%
70 16% 11% 7%

Source: Authors’ estimates.

The story for low earners and maximum earners is essentially the same.  The required savings rates  differ primarily because of Social Security.  Under current law, at age 67 Social Security will replace 55% of pre-retirement earnings for low earners and 27% of those earning Social Security’s taxable maximum.

It would be easy to assume a different target replacement rate or different levels of Social Security replacement.  Such changes are unlikely, however, to alter the basic message: starting early and working longer are far more effective levers for gaining a secure retirement than earning a higher return.

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    • I maximized my retirement contributions. Upon the advice of an estate attorney, my entire IRA was transferred to Fidelity. The advice of their “expert” was followed in distribution among TEN FIDELITY FUNDS, with no Retirement Fund suggested. Today, my account has decreased by seven (7) years savings, from the original amount. My recommendation: NEVER, NEVER, NEVER INVEST WITH FIDELITY.

    • I maximized my retirement contributions. Upon the estate of an estate attorney, my entire IRA was transferred to Fidelity. The advice of their “expert” was followed in distribution among TEN FIDELITY FUNDS, with no Retirement Fund suggested. Today, my account has decreased by seven (7) years savings, from the original amount. My recommendation: NEVER, NEVER, NEVER INVEST WITH FIDELITY.

    • Wealth is about freedom, it’s not about spending or consuming, but rather creating saftey and flexibility. Conventional wisdom states that a 10% savings rate over a lifetime is more than enough to build a healthy retirement. My personal view is that saving at least 20% will both get you to retirement (or semi-retirement, that’s my goal) quicker and ensure that you save enough to compensate for periods of poor investment performance. http://networthprotect.com/money/wealthy-ancient-rules-wealth/

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.

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