How Much Do You Need to Save for Retirement?

Romantic senior couple relaxing outsideMost Americans struggle to balance the burdens of daily expenses with the need to save for retirement. The firm resolve to resort to penny-pinching measure to free up income for greater savings often crumbles in the face of day-to-day financial realities. Actions taken to reduce financial stress such as spending less, using coupons, or comparison shopping are not consistently adhered to.

This was the general conclusion of an annual study commissioned by Scottrade that examined attitudes, behaviors and trends related to retirement. On the bright side, the same study found that 51% of Gen Xers (born 1967 to 1982, ages 29 to 44) said they started to save for retirement between the ages of 25 and 34. Compare this to just 30% of baby boomers who said they started saving at those ages.

A study by the Center for Retirement Research at Boston College (CRR) tackles the subject: how much should you save to retire comfortably? Much has been written on the subject and advice can often be conflicting. How much is enough, really?

The replacement rate concept underpins all discussion of how much one should save for retirement. It is defined as the rate at which retirees can maintain their pre-retirement levels of consumption once they stop working. Many factors come into play when calculating this amount because retirees do not need their full pre-retirement income to maintain their standard of living.

  • They pay less taxes. They no longer have to pay for Social Security and Medicare taxes, and only a portion of their retirement income is taxable, if at all.
  • Obviously, they no longer need to save up for retirement.
  • Because of the way terms of most mortgages are designed, they would have paid off all of their mortgages by the time they retire.
  • Work-related expenses for transportation and clothing are replaced by equivalents that are less demanding on the budget.

retiree2The same CRR study also cited the RETIRE Project at Georgia State University, which has been calculating required replacement rates (retirement income as a percent of pre-retirement earnings) for decades. The project estimates that households with earnings of $50,000 and over need about 80% of pre-retirement earnings to maintain the same level of consumption.  Households earning less need a higher percentage, because they generally save very little for retirement and pay much less tax while working.

How much of your monthly salary you need to put aside for retirement also depends on these 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.
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A 25-year-old worker earning a “medium” salary (about $43,000), who starts saving at age 25 and wants to replace 80% of his salary when he retires at age 67 needs to save 12% of salary annually, assuming a 4% rate of return on investments. For those who start saving at 35, the required savings rate jumps to 18%. Those who start at age 45 must put aside 31% of salary.

Use these calculators from Bloomberg, CNN Money, or Kiplinger to help you draw up a retirement savings action plan.

Here’s the most important point. The CRR study concludes that for workers at all income levels, the effective rate of return is less important to retirement-savings success than is the age at which you start saving, and especially, the age at which you plan to retire. It looks like the Gen Xers have this all figured out.

Check out the article on The Basics of 401(k) for more detailed information on the retirement fund options available to you.

Are you on your way to a comfortable retirement?

Category: Financial News

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