How Much To Save For Retirement
And how to calculate if your nest egg on track for retirement
|Written by Tom Yeung, CFA | CDFA|
Investment Advisor & Fund Manager, Jurnex Financial Advisors
Even among affluent families with a healthy income, one of the most common questions I get from clients is this: how much to save for retirement? And am I on track?
The answer can get complicated. Everyone’s situation is slightly different: some people have more substantial savings, while others might expect higher income in later years. It can feel overwhelming to know where to begin.
But that’s no reason to delay planning.
Instead, in this article, we’ll cover 1) the basics of calculating how much to save for retirement and 2) how to know whether you’re on track.
Because retirement planning is so important, I strongly recommend you reach out to an investment pro before you make a final decision. That’s because you want to know for sure if you’re on track for a great retirement. However, here are some guidelines to get you started.
The Importance Of Retirement Saving
Firstly, it helps to take a quick look at the importance of saving and investing.
Thanks to the power of compound interest, every dollar saved grows faster and faster over time. Whether you’re in your 20’s or your late 50’s, compound interest will still double your savings roughly every ten years if invested correctly.
But knowing how much to save can be tricky. The difference between saving 10% or 15% of your income might seem minor today, but someone saving 15% will have a nest egg that’s 50% LARGER, all else equal. (Mathematically, that’s because 15% is 50% larger than 10%).
And having a 50% larger nest egg can make the difference between having a comfortable retirement and running out of money in old age.
The Social Security fallacy
Social Security and Medicare (medical insurance for the elderly) won’t cover a comfortable retirement.
- Social Security. In 2019, the average retiree received just $17,652,
- Medicare. Patients are only reimbursed for stays longer than three days, but shorter than 100 days. You also pay $7,122 annually for Part A & B and have a $1,562 deductible.
While Social Security and Medicare can help fund retirement, I tell clients that their savings and investments should still be the keystone of their retirement plan.
How much to save for retirement?
Let’s take a look at some numbers.
The average American
The average American currently saves 7.8% of their disposable income. It’s low but still better than the 5% levels seen after the 2009 economic recession.
But is this enough?
Probably not. With a 7.8% savings rate over your lifetime, your income in retirement will only reach 46% of your final salary.
Yet, it’s even experts disagree on how much people need to save. The CFP board recommends a 10% savings rate, while TIAA-CREF suggests 20%. The difference might not seem large today, but that 10% difference DOUBLES your eventual nest egg size. And wouldn’t you rather have $5.0 million than $2.5 million?
Full income replacement requires 21.8% savings
If you want to maintain your salary through retirement without help from Social Security, you need to save 21.8% of your gross income. That’s assuming you’re starting at age 30 with zero debt, zero savings, and achieving a 5.5% real rate of return. (That’s your rate of return less inflation). It also assumes your income goes up by 1% every year and that tax rates remain relatively the same.
As you can see, many assumptions go into calculating a 21.8% savings rate. And it’s generally pretty unrealistic to assume that you’re 30 right now, let alone the 4-5 other assumptions. For instance, I mostly work with people between 40-65 who already have significant assets saved up.
However, I use this exercise because we need a base-line to start somewhere. And maintaining your salary through retirement sounds like a pretty good place to start.
Use 20% as a starting point for how much to save
I typically recommend people target a 20% savings rate as a base-line. Living expenses often decreases in early retirement, while Social Security and home equity can help plug shortfalls in spending needs.
This 20% number is contingent on many factors, including lifestyle, current savings, and investing risk tolerance, so later in this article, we’ll cover factors that affect this 20% figure.
Other Things To Save For
Keep in mind that the 20% savings rate only considers retirement savings. If you have other financial goals, you’ll have to save EXTRA. In other words, you don’t want to dip into your retirement savings to buy a car or to raise kids.
Here are the significant other factors to consider:
- Children and college education. According to Fidelity, the average child costs $233,610 raise to age 17. And if you live in a major coastal city, the cost of raising a child rises to $372,210, mostly due to having to upsize your house. Tuition for private education can add another $187,800.
- Leaving the workforce. Many parents decide to stop working to care for children. But leaving the workforce comes with a significant opportunity cost; giving up a salary can cost a family $2-10 million or more in foregone wages over twenty years.
- House. Whether it’s your first house or a dream retirement home, permanent residences require down payments, mortgages, and insurance. Unless you plan to sell the house (or use a reverse mortgage) to fund your retirement, don’t count on it as a retirement nest egg.
- Long term care. Long term care can cost $3 million or more. I generally recommend people have a separate healthcare savings plan in addition to retirement. Read more about long term care
Typically, I recommend clients save an additional 10% of their income for non-retirement goals. That way, they’ll have the extra cash on-hand if needed.
Are you on track for retirement?
To maintain your income in retirement, here is a rough guideline of how much is needed.
For example, if you’re 55 and earning $200,000 per year, your nest egg should be worth at least $2.0 million.
Don’t count the value of your primary residence
I usually recommend people NOT count their primary residence towards their nest egg unless they’re willing to sell the house to fund their later years. But of course, people who plan on downsizing in retirement might want to count a portion of home equity towards funding their retirement.
Factors that increase how much to save for retirement
Even though a 20% savings rate is ideal for many, here are factors that can cause individuals to need to set aside MORE.
1. Not enough savings
Typically, a 50-year-old should have about seven times their annual salary saved for retirement. By age 60, they should have 13 times or almost double that.
But if you’re short, you’ll have to catch up with savings.
Fortunately, the IRS has special programs for people over 50, known as catch-up contributions. These rules increase IRA contribution limits to $7,000 and 401(k) limits to $25,000.
Individuals with smaller nest eggs should consider saving 25-30% or more of their income.
2. Desire to retire early
People looking to retire early have to set aside much more. Firstly, they’ll have fewer years to grow their nest egg. And secondly, they’ll have many more years of retirement to fund.
For example, an individual who wants to retire ten years early at age 55 needs 15-20 times their target annual income invested by the time they reach age 50. Achieving early retirement can mean saving 35-40% or more of your income.
3. Gender – women need to save more for retirement
According to the Social Security Administration:
- A man reaching age 65 today can expect to live until age 84.0.
- A woman reaching age 65 today can expect to live until age 86.5
Women also spend more on health care in later life. That’s one reason Genworth, an insurance agency, estimates that the cost of long term care insurance for women is about 30% higher for women than for men.
Women should save 21-22% of income, versus 20% for men.
4. Health risk factors
According to the National Center for Health Statistics, there are five key risk factors to consider when thinking about health outcomes:
- High blood pressure
- Elevated blood sugar
- Genetic risks
These risk factors can increase the cost of healthcare in retirement (though possibly shorten lifespan too). Consequently, those with higher risk factors also need to save additional towards their health care plan.
5. Lower risk tolerance
Growing your nest egg involves taking calculated risks with your investments. Some people, however, are less willing to invest in stocks or real estate.
Investors who prefer ONLY long-term bonds need to set aside up to 35% of their income. That’s because bonds typically return 2% LESS than stocks, which means you have to save more to make up the difference.
Fortunately, it’s still possible to decrease investment risks and maintain reasonable returns. Contact us today and learn how.
Factors that decrease how much to save for retirement
Some elements can also decrease the amount you need to save for retirement.
1. Expected inheritance
If you’re a beneficiary of an irrevocable trust, you can usually count the proceeds towards your retirement plan.
However, don’t count revocable trusts towards your retirement plan. That’s because beneficiaries of a revocable trust or inheritance might never receive the money. Parents can fall ill and require expensive medical treatment. Or they can change their minds and adjust the amount they pass on to their children.
2. Retiring to a low-cost location
Those planning to retire to a cheaper area can save less for retirement. According to International Living Magazine, an individual retiring to Panama City can expect to pay just $2,600 per month, including rent, food, utilities, and entertainment. That’s compared to $8,400 per month in Washington DC, San Francisco, or New York City.
However, be sure to check up on medical care costs. Many low-cost countries have reasonably-priced health care for foreigners, but Medicare won’t help pay for treatment.
Regardless of where you retire, I still recommend saving no less than 15% of your income. That’s in case you change your mind and want to move back to the US later in life.
3. You’re ahead in savings
If you’re ahead with your savings plan, you can often afford to save LESS for retirement. That’s because, thanks to the power of compound interest, your investments can grow faster than the contributions you’ll need.
There are a couple of ways to get ahead in your savings.
- Invest wisely and aggressively. Smart investing can help you get ahead. Early investors in companies such as Amazon saw their initial investments multiply hundreds to thousands of times. The trick is to identify these companies early and stick with them for the long run.
- Start a business. While starting your own business has many upfront costs, the rewards over the long run can be significant. 47% of millionaires are business owners.
- Manage cash flow. Staying on top of your cash flow can help you save more money in earlier years. By paying down high-interest debt quickly and channeling the savings into Investments, you can grow your savings far faster.
4. Willing to work in retirement
Working in retirement comes down to personal preference. If you’re the type who enjoys working and can stay at your career beyond age 65, there’s a good chance you can save less for retirement.
This strategy, however, comes with certain risks. You need to make sure you’re in good health, have skill sets that won’t deteriorate over time, and be willing to learn and grow for life.
But for those who love to work, the benefits can be felt many years into retirement. According to academic research, people who work even one extra year after 65 had a 9-11% lower mortality chance over the following 18 months.
So how much do you need to save for retirement?
Calculating how much you need to save for retirement can be tricky. That’s because the right savings rate depends not only on your current financial situation but also on your future risk factors, desires, and plans. For those who have a spouse, the decision won’t be made by a single person either. It will be a combination of two opinions and lives.
That’s why I highly recommend clients do a financial review every couple of years to make sure they stay on track.
Where to find more resources
If this seems like a lot of information, don’t worry. The great news is that help is available. That’s because here at Jurnex, we work with individuals and families just like you to make the most out of investing. I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great companies in great industries that can you can buy at a discount to their fair value. Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.
We are an independent registered investment advisor and asset manager. We have the securities backing of Charles Schwab, yet we retain our operational independence from any third party. This means you can have the confidence your money is safe with one of America’s best brokerages and still receive knowledge and advice from an independent firm focused on YOU.
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