How Much Should I Have In Retirement Savings At My Age?

Fidelity, a major player among 401(k) providers, announced new age-based savings guidelines last week. These benchmark values are intended to help workers stay on track for retirement, and are welcome in a world where the majority of Americans are responsible for saving for retirement on their own, with very little guidance.

According to the Fidelity guidelines, you should have 1x your annual salary at age 35, 3x at age 45, 5x at age 55, and 8x your salary in savings at retirement in order to retire on 85% of your salary. But is that enough?

The Fidelity calculation solves for an 85% income replacement ratio, which I think is fairly accurate for most people. Remember that you won't be saving for retirement anymore, which frees up a chunk of your income. In this hypothetical simulation the worker will being contributing at age 25, work and save continuously until 67, and live to age 92. The market returns used are 5.5%, and it assumes that the employee’s income rises 1.5% over inflation every year.

However, this simulation also assumes that you will collect social security immediately upon retirement, and I wouldn't bet on that. My guess is that our generation won't be able to access social security until age 70 or 75, which is actually more in line with the program's design. The problem with delayed social security income is that your early retirement income needs are likely higher than those in later retirement because that's when you are healthy enough to travel and enjoy expensive hobbies. So let’s assume that your first 5 years of retirement are funded solely by your retirement savings. If you retire with 8x your last year’s salary in savings, and in the first year you withdraw the equivalent of 85% of your salary, your withdrawal rate is over 10% a year! That is way too high. In other words, 8x your salary at retirement is not enough. 

Think of it this way: If your ending salary is $100,000, you would be aiming for a final balance of $800,000. Out of that, you would pull $85,000 the first year. That's 10.5%! I would never let a client head into retirement with that distribution plan.  I understand that the purpose of this study is to get Americans to save more (the average Fidelity 40(k) balance is $73k), but it seems to me that their benchmarks are way too low. 

Based on my calculations, the numbers should read as follows:

Age 35- 1.25x salary

Age 45- 3.5x salary

Age 55- 7x salary

Age 67- 14x salary

At 1.5% income growth, your $62,000 salary would be $100,000 at age 67, which means you would want at least $1.4 million in savings at retirement. You can then pull out $85,000 a year and still keep the withdrawal rate to 6%. This would still be a high withdrawal rate if you were planning to only withdraw from your savings, but as I mentioned earlier I do believe that social security benefits will kick in at some later point in our generation's retirement.

While benchmarks can be helpful, there are many problems with judging whether your retirement is on track by the balance at a particular point in time. It may give you a false sense of security. Two people, one who turned 35 in 2007 and the other in 2009, would have very different ideas about their retirement readiness. Another problem is that, for most people, life refuses to be linear. You may have to cut your savings during child-raising years, upon starting a new business, or during a lay-off. Finally, remember that everyone’s situation is different. A doctor who graduates medical school at age 30 with $200,000 in student loans will have a difficult time reaching those early targets, but will be able to contribute far more in the future.

Instead of your retirement account balance, focus on your savings rate. This is the area in which you have the most control. Aim to put away a total of 15% of pay (including your employer match) toward retirement each year. If your employer matches 3% of your salary, this means that you should contribute 12%. The Fidelity study actually builds up to a 15% savings rate (including employer contribution) by age 35. I actually recommend saving a portion of those funds in a Roth IRA if you qualify, so your 15% retirement contributions may look more like 5% Roth IRA, 7% 401(k), 3% employer match. If you are self-employed, pull out 15% of each check before you can spend it (as you should be doing with the taxes you will owe at the end of the year). In order to get to the 14x salary you will have to increase your retirement contributions to 20% for the last ten years of employment, which is typical for families who are able to ramp up retirement savings once the kids are through college.

Since not everyone can afford to contribute 15% right off the bat, many workers (myself included) may not get to 1.5x salary by age 35. In this case you will need to increase your savings rate a little higher to get on track. For instance, you may pay off a credit card or student loan and redirect those funds towards retirement savings. However, I wouldn't recommend lowering your contributions below 15% (again, including what your employer puts in) even if you are on track to hit the benchmark number earlier. 

You may choose to diversify your savings into different investment vehicles such as rental properties or alternative investments. Just keep in mind that 15% of your income goes into SOME sort of savings or investment vehicle every year. If you have 1.25x your current salary at age 35 and you continue to save 15% of your income, you will be on track to retire with 85% income replacement at age 67.

It bears repeating that everyone’s financial situation is different. Sitting down one-on-one with a financial planner is the best way to determine the optimal savings solution for you.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.