Are You Saving Enough?

It’s America Saves Week, so it’s a good a time to look at how much you are saving, and whether it will be enough to keep you financially secure when you stop working for pay. Less than half of Americans have attempted to figure out how much they need to save according to the twenty fifth annual Retirement Confidence Survey done by the Employee Benefits Research Institute (EBRI). Those who have done an estimate tend to have higher savings goals, but many admit that their number is really only  a guess.

Of course there are a lot of factors that go into figuring out what you need in order to leave work at some point in the future. There are the income oriented pieces including how much Social Security will pay, and whether you will have a guaranteed monthly income from a traditional defined benefit pension plan. But in order to know how much you need, you also have to know how much you plan to spend when you stop working. To know how much you will spend there is a lot to think about. Will you work part-time? Will you spend money on travel or hobbies? Will you stay in your home or move? There are so many unknowns that the task of figuring out how much you need can become overwhelming, and that may be why so many don’t do it.

Unless you know exactly how you want to spend your life after work, and congratulations if you do, I like to bring the thought process down closer to earth. A reasonable thing to assume is that you will spend at least what you are spending today. The EBRI study found that nearly three quarters of retirees said their expenses were the same or higher than their expenses before retirement. Working from what you are currently spending allows you to get started right away, and if your plans change, you can adjust your savings accordingly.

On the income side, you can find out how much you can expect from Social Security by creating an account on the Social Security Administration web site. To calculate your benefit, Social Security uses the average of your 35 highest earning years. A medium level of average lifetime earnings are estimated at about $45,000, and would provide a benefit of $18,500 per year. High average lifetime earnings is estimated at $72,000 and would provide a benefit of $24,500 per year. The highest benefit would be about $30,000 per year. Translated to monthly terms, that is $1,500, $2,000 and $2,500 per month respectively.

Unfortunately, unless you work for the government or a union, you likely do not have a defined benefit pension plan. Only 10% of large private employers still offer the benefits. So other than Social Security, you will be living off what you save. How much do you need to accumulate? Seemingly daily there are articles about rules of thumb and which ones you can still use and those you can’t. However, to get started, you can assume that every $100,000 you save will allow you to spend $333 per month when you stop working, given a reasonable investment return and a normal retirement age.

What might this look like in a real calculation? For illustration purposes assume that you earn $75,000 per year, and you are currently saving 7% ($5,250 per year) of your salary in your company sponsored 401(k) plan. This contribution rate is the average across plan participants as reported in “How America Saves“, a survey of retirement plans using Vanguard Retirement Services. Your take home pay is around $45,000 after taxes and other benefits. If you aren’t saving outside your retirement plan, that is about what you are spending. So monthly you spend $3,750.

Social Security will provide $2,000 per month, and with that you will need to come up with an additional $1,750. If you retired today, you would need $525,000 to be able to withdraw enough to make ends meet. If you are 40 and have the average balance for someone your age, you have about $65,000 in your plan, and you are behind.  To replace your current level of spending you would need to be saving about $10,000* per year. Investment returns will help by covering the growth in your expenses due to inflation and providing a boost to your own savings efforts. But there is no substitute for saving more.

I can hear you gasp. There isn’t any way that you can live on less money. However, you can meet yourself somewhere in the middle. Most of those surveyed by EBRI indicated that they could save more than they have been. If you increase your savings, you will be spending less, and therefore you will have less to replace. You can also gradually increase your savings rate over time as your earnings rise. The more that you do, the closer your future lifestyle will be to your current one.

There are a variety of free retirement savings calculators available on-line. They will have varying underlying assumptions, but any of them will give you a place to start to figure out how much you will need to save each year to maintain your lifestyle in retirement. Here are a few that you can try:

Charles Schwab Retirement Calculator

Vanguard Retirement Income Calculator

AARP Retirement Calculator

Most of us will have to provide for much of our own income after we stop working. It’s easy to get side tracked by all of the unknowns in figuring out how much you need to save. Fortunately you can simplify your assumptions, and there are free resources to help you get started. You can always adjust your strategy as you learn more. Take some time this week to see where you stand in securing your own financial future.

*Assumed investment return of 5% and inflation of 2%

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