There was an article in Financial Advisor magazine this month which talked about how much money people ought to save if they wish to retire comfortably. I’ve found people enjoy these simplified, rule-of- thumb type systems as they allow people to break down complex, hard-to-reach goals into smaller, more manageable pieces. The article suggests that saving 8x your final salary should, along with social security, prevent a situation in which one outlives their assets. Obviously this isn’t an exact science as the retirement picture looks a little different for everybody, but based on standard spending ratios (typically 85% of pre-retirement income will be needed) these numbers should work. The ways in which one may reach such a large lump sum goal will vary but below are the suggested guidelines for doing so.*
Starting at a young age is the first and most crucial component to hitting the goal: by age 35 you should aim to save 1x your salary. After that, the next goal is 3x your salary by age 45, 5x by 55, and 8x by retirement, presumably at age 67 which is around the time most people will turn on social security and receive unreduced benefits, even if they are still working.
In order to reach the 8x mark, you would need to begin 401k contributions at age 25 and save continuously through age 67. The final 8x goal includes savings primarily through retirement plans at work, but if you either don’t have a 401k or 403b at work, or you max it out with your contributions, those savings can be made either through traditional and Roth IRA accounts or through after-tax investment accounts. Other assumptions include a 6% contribution rate to the workplace retirement plan starting at age 25 which increases by 1% per year until you reach 12% or max out. It also assumes a 3% annual employer match. Obviously not all workplaces offer the same benefits so some of the savings goals may need to be achieved in other ways. If your employer doesn’t offer a match, you may need to cut additional spending and save a greater amount in after-tax accounts.
Built into the above guidelines is also a portfolio growth rate of 5.5%. One may hope that the markets outperform that figure going forward, but when retirement planning, it’s always better to use conservative figures. That figure is also a bit more realistic when considering the fees and expenses included in 401k plans which often drag down returns over long periods of time.
The ways in which one reaches their retirement savings goals will vary, but having these short, medium, and long-term numbers as a point of reference will make the planning process much easier. The other half of the equation is containing your expenses. Even if you are a high earner, that just means your retirement is going to be more expensive to keep you in the style which you’ve grown accustomed to. Learn to have expenses well below your income at a young age. That mentality of having to save will make your life much, much easier in the future.
As always, feel free to reach me with any comments or questions.
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*The 8x salary number was conceived by Fidelity Investments and published in the October, 2012 edition of Financial Advisor magazine.