How much should I save for retirement? Wouldn't you like to know? Most of us wonder if we've really set aside enough for life's later stages, especially after two bear markets and two recessions in less than a decade. (And more financial and economic trouble looms with the Eurozone on the brink of collapse.) I'll bet most of us believe we haven't.
How does anyone figure out how they're doing? The short answer is you can't know. There is no magic number, no infallible rule of thumb that that solves the retirement savings equation. There are too many imponderables, from personal health to the business cycle. Still, it's helpful to get a sense of how you're doing and there are a number of different ways to a stab at guessing your number.
The retirement mantra these days is save more, work longer and delay taking Social Security. The Center for Retirement Research at Boston College has published a study that tries to get at the number--and its results echo the mantra.
The main variables highlighted by Boston College scholars Alicia Munnell, Francesca Golub-Sass and Anthony Webb are when savings starts, the age of retirement and investment strategy. Their benchmark is the so-called replacement rate. Essentially how much do you need to maintain the same standard of living before retirement while you're in retirement? It's a rough rule-of-thumb, and they use the common income replacement rate of 80% for a medium income household with $50,000 in earnings.
Low-income households should shoot for 88%, they guesstimate, because they typically have fewer saving. Higher income households can set a target of 81%.
This chart shows the recommended savings rate for the medium earner, assuming a 4% average annual rate of return. The goal is an 80% replacement rate.
It's interesting to note how much the required savings rate drops if you start at 25 rather than waiting for age 45. It cuts the savings rate by two-thirds. Delaying the age of retirement from 62 to 70 also slashes 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 percent of earnings to achieve an 80-percent replacement rate at retirement, roughly one tenth of the rate required of an individual who starts at 45 and retires at 62 - an impossible 65 percent. But note that even that individual who starts at 45 has a plausible 18 percent required saving rate if he postpones retirement to age 70> .
The next chart looks at the savings rate for medium earners but assumes different inflation adjusted rates of return--2%, 4%, and 6%.
Again, I find it striking how powerful is impact on the replacement rate of delaying the age of retirement.
Studies like these are helpful in that they give us some benchmarks to think about. But the information is limited. The assumptions are stark. Averages are often misleading.