"You can be young without money, but you cannot be old without it."
Imagine… you are sitting on a beach. Listening to the waves slap the sand in a rhythmic melody. It is the same soothing tune you hear each day since you left your job. As you relax in your beach chair reading a thrilling novel on this quiet stretch of sand, a horrible thought comes into your mind. Then, just as quickly as it came, you smile and go back to your reading.…
This horrible thought was that you have not saved enough for your retirement. Fortunately for you, you have prepared for retirement. You don’t need to worry about anything other than what time you are going to tee off at the golf course.
Unfortunately, this is not the case for 41% of Americans between the age 55-64 years old. A recent study done by the US Government Accountability Office (GAO) shows that 41% of households age of 55-64 have no retirement savings. That’s right ZERO.
That is a scary thought.
The goal of this post is to address the retirement savings crisis, tell you how you can solve it for yourself, and to show you my three simple methods of calculating your retirement savings goal (including my "live forever" method).
- The American Retirement Savings Crisis you were not aware of.
- 2 Key Questions you need to answer about your retirement savings.
- 3 Methods to quickly and accurately calculate your retirement savings goal.
- How much in retirement savings you need at 25, 30, 40, 50, 60 years old.
- Determine how inflation affects your retirement savings.
How Much Retirement Savings Do You Need to Retire Without the Stress of Running Out of Money
What do you think about when you think about retirement? Does it look like.... Sitting on a beach, with the waves lapping on the sand while you read your favorite book, enjoying the warmth of the sun on your skin. Or do you worry about living off of ketchup and crackers with only social security for income?
Beachfront property isn’t cheap and neither is food. How much money do you need in retirement savings to make that dream a reality? $100,000? $500,000? $1,000,000 or more in retirement savings?
Depending on where you live and your expense needs, that number can vary. Many people move from a higher cost of living state to a state where the it costs less to live when they retire. This makes sense from a financial perspective, but do those states provide you with what you need in retirement? Do they have great medical facilities? Do they have access to the hobbies you plan on engaging in when you are retired? Are they close to your family and friends? Is there access to transportation?
These are all important questions to answer if you are looking to retire. However, the two most important questions to answer are: How much should I be saving for retirement? and When should I start saving for retirement?
Retirement Savings Crisis: Americans Not Saving for Retirement
Did you know there is a retirement savings crisis in the US?
I don’t mean the huge demographic trend where baby boomers are going to retire and pull their money out of the markets to spend. I am talking about retirement savings. The money you have saved to supplement your income during your retirement years.
If I asked you to guess, how much do you think the average American family has in retirement savings? $250,000? $500,000?
According to the Employees Benefits Research Institute, in 2013 the median retirement savings for all families in the US was $5,000.
No, I did not leave out a few zeros. $5,000 is the total amount that the median family has in retirement savings in the US. "Median retirement savings" measures those savers at the 50th percentile of the population. This reiterates the GAO study of 41% of the population having zero in retirement savings. Most people have next to nothing n retirement savings. That is why we have a serious crisis on our hands.
Average Retirement Savings
Let’s look at the numbers a different way. If you look at the average retirement savings of all Americans (the "mean" - total amount in retirement savings divided by the number of Americans), you would get an average amount of $95,776. That seems a bit more normal to you, right?
This much higher average is due primarily to the fact that some people have no retirement savings and others have hundreds of millions of dollars. Although the ultra-rich are fewer in number, they obviously skew the numbers as an average.
Even with this much higher number, living off of $95,776 in retirement savings to supplement your social security income in retirement can still be challenging. There are a lot of proposed solutions to this retirement savings crisis, but only a few that you have any control over personally. Let's try to solve this problem by presenting you with some methods that a working person of any age can use to enhance their retirement savings.
How Much Do You Need To Retire?
There is as much opinion about how much you will need as there is about where you should retire. There are numerous rules of thumb, complex calculations, and estimates based on numbers that are not likely to happen. Here are some of the opinions of larger financial institutions.
- Fidelity suggests that workers save eight times their ending salary by retirement.
- David Blanchett, head of Morningstar research, tested “the 80% rule” and suggests that 70-80% of your ending salary is a good estimate for the income most households will require in retirement.
The obvious question that comes to mind when I read these 2 statements is, "how will you know what your ending salary will be when you retire?" This is a much harder question to answer than how much money you will need.
How will you know what your ending salary will be when you retire?
I find the best way to solve this problem is to start at the end and work backwards. First we need to establish a few “facts” to solve this problem, then we can help you find your answer.
When Are You Going To Die?
Sorry to be morbid, but this is important. Unless you know the future or have visited a gypsy lately, you probably don’t know the answer to this question. So, let’s take an educated guess. If you are 50 years old, the Social Security Website, says you will live to around 82.2 years old. The genetic history of your family will also allow you to raise or lower this a bit, so let’s say for this example, you will live to 85 years old.
When Are You Going To Retire?
This can be hard for a lot of people to get a handle on at a younger age. Let’s say for this example, you plan on retiring at 65 years old. This means you will have 20 years that you need to fund without a working income.
What Are Your Expenses In Retirement?
This number is based on your basic expenses (housing, food, utilities, etc.) plus some additional expenses for your expected lifestyle. Obviously if you want to travel a lot, it may cost you more than if you want to spend your time locally volunteering at a non-profit. Let’s say your basic living expenses are $3,000 a month.
How Much Is Your Social Security Benefit?
This is easily calculated on the social security website. It will mainly depend on how much you earned in your career. Let’s say you have a $1,500 in social security income at age 65 years old.
Do You Have A Pension?
This concept of a pension is foreign to people in the younger generations. Pensions were a great employee benefit decades ago, but they are harder to find now. I’ll leave the amount at zero to make the calculations simpler.
How Much Do You Have In Retirement Savings?
This is the number that shows your ability to plan ahead. Did you start saving early or did you wait till your kids were out of college? How much do you have designated as retirement savings? Let’s say for this example you saved a total of $100,000. According to the ECI, this (actually $95,776) is the average amount of retirement money saved.
What Is The Rate Of Inflation?
Inflation is an important calculation, but it is also a guess, so it is unpredictable by nature. I will ignore this assumption for simplicity purposes, but you should consider the impact of inflation on your retirement savings. I discuss the impact of inflation on your retirement savings plan at the end of this post.
How to Calculate Retirement Savings Need For My Family
Now that we have established the facts. Let’s, summarize what we have:
- You will receive $1,500 a month in social security benefits
- You need $3,000 a month to pay for your expenses
- You will need a net of $1,500 a month in income to supplement the social security income.
- You have $100,000 and will need it to last 20 years to cover basic retirement expenses.
IMPORTANT NOTE: You should realize that in addition to the monthly retirement expenses, there will be unexpected expenses that can come up as well. These could be items such as medical expenses, needing a new car, or paying for a new appliance. This is why it is important to have an emergency fund. These are funds that are saved in excess of retirement savings, and used only for emergencies. They should not be calculated into your retirement savings.
How will you get an extra $1,500 in income to pay for your expenses? This amount comes from your retirement savings. This is why you saved money into your IRA and 401k each year when you were working, to pay for this income deficit. The average American has enough retirement savings to last a little more than 3 months when they retire. They do not have enough to retire unless they plan on only eating ketchup and crackers. People who do not have enough in retirement savings will have to seek help from family or keep working to find ways to supplement their income.
Let's look at the three methods of calculating how much you need to retire.
3 Methods to Calculate Retirement Savings
We have created three simple methods of analyzing how much you need to save for retirement (based on your retirement income deficit). Let’s look at each one.
1 - The "Dipping Into Savings" Method
The purpose of the first method is to draw a baseline. It is the most basic method with basic assumptions. I look at this as the worst-case scenario method. It assumes you took almost no risk with your retirement savings. You only have what you saved. No growth of the money has taken place. How long would the $100,000 in retirement savings last?
You need an extra $1,500 a month to supplement your retirement (based on your expenses). This comes out to a net of $18,000 a year in expenses to supplement your income. If your $100,000 is sitting in cash, this would last you 5.5 years. If you retire at 65 years old, you would run out of money at 70.5. This is 15 years short of your death, so this is a problem. Using the dipping into savings method, you would need a total of $378,000 to live to 85 years old. Using this method, you would need to save an additional $278,000.
2 - The "Traditional 4%" Rule
The Traditional 4% rule looks at the problem a bit differently. The Traditional 4% rule states that if you withdraw 4% of your savings during your first year of retirement and adjust subsequent withdrawals for inflation, your savings should last 30 years. This method does not account for how much you need. It only accounts for how much your savings can provide. To put it another way, this method would be most useful at or near retirement when you know how much you have saved and want to determine how much you can spend.
If you wanted to use this method earlier in your life, you could use it as follows. For example, if you needed an additional $18,000 a year, you would take $18,000 divided by 4% and you would get $450,000. This is the amount you would need in retirement savings. The 4% rule is not perfect, but it should give you a good estimate of the amount you need.
Using the Traditional 4% rule you would need to save an additional $350,000 to meet your retirement goal
Note: We are not using inflation in our assumptions, but you should include inflation if you are using this method. Inflation has been consistently positive since the late 1940s, but it does not mean that this will continue to be the case.
You should also note that this method does not take into account the variability of the investments going up and down at inconvenient times.
For example, over the last 100 years the stock market has averaged 8.4%-10.5% (the variations depend on the time frame you use to measure performance). The 100 years prior to this, the average annual return of the stock market was -0.86% and 0.48%. These numbers are averages over 20 year to 100 year periods of time in length. The year to year returns had a much greater volatility. Don't rely on your recency bias to predict future performance of your retirement savings.
3 - The "Living Forever" Method
This third method is what I would call the ideal scenario for your retirement. This means that you have enough money to become financial independent and can retire when you want. This could happen at 40, 50, or 60. Being financially independent means that your passive income exceeds your expenses.
How can you get your financial freedom in retirement?
This could happen if you had a pension that paid you $1,500 or more each month, or your investments paid you $1,500 each month, or your expenses were lower than your social security income. People call this financial freedom because you no longer have to worry about your income to survive.
For our scenario above, the only option is to have enough in retirement savings to generate a sufficient amount of income to live forever. This is called living off the income.
In order to figure this out, you would calculate what income is needed for your annual expenses ($18,000) and what return you could safely expect for the next 20 years, and come up with a number. For this example, let’s assume that you would earn 3% in safe income. At 3% you would need $600,000 in retirement savings to earn $18,000 a year. This means you would have to save an additional $500,000 to meet your retirement goal
The living forever method is my favorite method of planning since it allows you to consider your retirement savings as a tool so you don’t outlive your money. The other methods assume you will run out of money at a certain end point. This does not. If you wanted to leave a legacy to your kids or a charity, this is a good way to preserve your wealth.
…And who knows. With the progress of technology, people may be able to life forever during your lifetime. What was science fiction, may become science fact… Sorry I was back on that beach in the warm sun.
The odd are high that you do not have the exact financial numbers I have used in the example above. If you want to get a version of our retirement savings calculator to calculate your own numbers, click the button below to get Free Instant Access to our Retirement Savings Calculator.
Retirement Savings By Age:
How Much Should I Save In My...
Now that we have these three methods of estimating your retirement savings needs, let’s figure out how much you need to save at each stage of your life to meet these retirement savings goals. I will use these three methods as a baseline of where you should end up if you are a consistent retirement saver.
Saving for Retirement at 25
Most young adults have a strong headwind in their face in while they are in their 20s. They have on average $30,100 outstanding in student loans and an average income of $32,500. This ratio of low income to high debt makes it hard to save money for retirement. Most of these young adults are just trying to survive. It is no surprise that at this stage of their lives many of them are not saving anything for retirement.
If you know anything about the power of compounding, you will realize that this is the best time to start saving for retirement. The money you save today will have a much greater capacity to grow over time than money you save 10-20 years from now.
Here is an example of the power of compounding. Let’s say you started saving $5,000 each year at age 22. Let’s also assume you earned 5% a year on your savings. When you reach the age of 70 years old, you would have over $1,000,000. It would take you 48 years to save $1,000,000 by saving only $5,000 a year. However, it would a only take you an additional 13 years to get to $2,000,000. How is that for compounding?
It might be challenging to save $5,000 a year when you have a large student debt to pay off, but the upside is huge. You should also consider that if you are employed by a company that has a company 401k match, you might not have to come up with all the money yourself.
Assuming you start your retirement saving plan at 25:
- Dipping Into Savings Method - You should try to save at least $2,400 in retirement savings each year.
- Traditional 4% Method - You should try to save approximately $3,000 in retirement savings each year.
- Living Forever Method - If you want to live forever, you should try to save approximately $3,800 in retirement savings each year.
Saving for Retirement at 30
Now that you are in your 30s, you are all grown up (hopefully). You have graduated college and possibly even graduate school (i.e. more student loans). You might be married with a few kids. You might even be able to afford a home.
These new expenses are making it hard to save for retirement. This shows up in the EPI statistics. According to the EPI, the median retirement savings for people between 32 – 37 is $480. Unfortunately, this will make it harder to save for retirement. While you may not be thinking about retiring in your 30s, you should.
According to our retirement calculator, if you started saving for retirement at age 35 and saved $5,000 a year at 5%, you would only have saved $371,494 by age 65. This is a bit shy of enough in retirement savings if you use the dipping into savings method. Your solution would be to either stretch out your retirement to a later year or to save more each year prior to your retirement. If you want to travel the world in retirement, you will need to save more.
Assuming you start your retirement saving plan at 30:
- Dipping Into Savings Method - You will have to save $3,800 a year in retirement savings to meet your retirement goals.
- Traditional 4% Method - You will have to save $4,500 a year in retirement savings to meet your retirement goals.
- Living Forever Method - You will have to save $6,000 a year in retirement savings to meet your retirement goals using this method.
Saving for Retirement at 40
Your 40s are the time when you are starting your prime earning years. You should be making a lot more than when you were in your 20s and this should allow you to do more things for your family. This includes buying a bigger house, going on vacations, buying a car for your kids, maybe even paying for their education.
While your income increases during these years, your expenses do as well. It is easy to overlook retirement savings during this period since it is 25 years away, but this is exactly when you should be maxing out your retirement savings through work. Even though we used a consistent $5,000 a year in savings for our example above, many people increase their retirement savings during their 40s and 50s to make up for saving less in their younger years. If you have not started saving for your retirement until now, you will need to increase you annual contributions.
According to the EPI statistics, the median retirement savings for people between 44 – 49 is $6,200 in 2013. This is obviously not enough to live the lifestyle you want.
Assuming you start your retirement saving plan at 40:
- Dipping Into Savings Method - You will have to save $7,050 a year in retirement savings to meet your retirement goals.
- Traditional 4% Method - You will have to save $8,400 a year in retirement savings to meet your retirement goals.
- Living Forever Method - You will have to save $11,200 a year in retirement savings to meet your retirement goals.
Saving for Retirement at 50
Your 50s are a time when you are in your peak earning years. Hopefully you have hit an earnings potential you are happy with. However, along with this higher income comes more expenses. Assuming you are helping your kids pay for college, this will take a big chunk out of your income. You can also add the costs of maintaining your home, increased medical costs and potentially supporting a college graduate who has not found a job yet.
Despite these increased costs, you should be able to save a good amount of money during these years. If you have not been saving since your 20s and 30s, you will have to use these years to make up for lost time. I find this is the more common way that people save for retirement, so don’t feel bad if you are starting later in life. Just understand you missed out on the benefit of compounding your retirement savings.
According to the EPI statistics, the median savings for people between 50 – 55 is $8,000 in 2013. This amount is not encouraging, but if you look at the average retirement savings amount, it is closer to $124,831.
Assuming you start your retirement saving plan at 50:
- Dipping Into Savings Method - You will have to save $15,200 a year in retirement savings to meet your retirement goals.
- Traditional 4% Method - You will have to save $18,100 a year in retirement savings to meet your retirement goals.
- Living Forever Method - You will have to save $24,200 a year in retirement savings to meet your retirement goals.
Saving for Retirement at 60
You are in your 60s. This is your last chance to save for retirement. While some professions will allow for you to extend beyond 70, it generally doesn’t apply to most people. While this may be the last chance to save for retirement, it is also the time when you should have the best chance to save. Your expenses should be lower if you have paid off your mortgage, and your kids should be through college. Excluding your basic expenses (unless you have young adults living at home) your expenses should be minimal. All the extra money can go directly to your retirement savings. This will allow you save as much as possible so you can enjoy your retirement.
According to the EPI statistics, the median savings for people between 56 – 61 is $17,000 in 2013. The average retirement savings for people 56-61 is about $163,577. Their study only went to age 61, so we don’t have much data for people in their 60s, but we can estimate that the average would not be much above $200,000 and the median probably not much higher than $25,000.
Can you live off $200,000 in retirement savings?
Assuming you start your retirement saving plan at 60:
- Dipping Into Savings Method - You will have to save $53,000 a year in retirement savings to meet your retirement goals.
- Traditional 4% Method - You will have to save $63,000 a year in retirement savings to meet your retirement goals.
- Living Forever Method - You will have to save $84,000 a year in retirement savings to meet your retirement goals.
Does Inflation Affect Your Retirement Savings Goals?
Yes, Inflation does affect your retirement savings numbers. As I'm sure you noticed, I deliberately omitted inflation from my above calculations... I'll explain why.
Inflation is a part of every calculation made for retirement. It can make the calculations very confusing.
Inflation slowly eats away at the buying power of your savings. In order to offset this inflation problem, you will be forced to earn money in excess of inflation to keep it from reducing your savings over time.
Take a look at the performance numbers above again. You will notice that my performance numbers above are very conservative (e.g. 3% & 5%). This is because I used "real returns" (meaning returns after inflation). If you add inflation to the numbers above you will essentially get the same outcome as nominal returns in a range that is less conservative. This is why it is simpler to remove inflation from all the calculations and use lower performance numbers.
It would be extremely difficult if not impossible to estimate the rate of inflation over 20 - 40 years. You could not do it with any more accuracy than you can predict the performance of your investments over that period of time. The best you can do is to remove inflation and use conservative performance numbers so they can be considered real returns in your calculations (compared to nominal returns).
Also it should be noted that the CPI (Consumer Price Index - how we generally measure the rate of inflation) is used for COLA to adjust prices. Many pensions use COLA to adjust their retirement benefits. Overall the CPI is a good estimator of the inflation you will see in your expenses. However, you will see some expenses, such as health care that are much higher than the CPI.
We monitor these inflation numbers each month in our inflation monitor. We publish this free report to provide you with a simple solution to tracking inflation. This report also provides you with relevant charts and other statistics so you can see what is going on with inflation from different perspectives. This is one of our more popular reports.
Too many Americans are saving less than they need to. While this is a big problem, a bigger problem is the runaway costs of health care and medication. This will become a progressively larger portion of a person’s expenses as they age.
In general, you should consider inflation with your predictions, but don’t lose sleep over it. For the past 60+ years we have had persistent positive inflation, but that is not an assumption that needs to hold true. For example, Japan has had 30 years of deflation. Deflation has been very destructive to their asset prices, such as real estate. It is not worth making important decisions based on assumptions which are highly variable, so in many cases it is best to remove it for simple calculations if at all possible.
What Should You Do Now?
If you don't know where you are going, how do you know when you have arrived?
The first thing you need to do is to create a retirement plan. You can create one yourself or you can hire a financial planner (like me) to do it for you. This type of retirement plan will outline how much you need to save and when you can ultimately retire. It will also help you plan for other goals such as leaving a legacy for your heirs or a charity of your choice.
Looking for Financial Advice - If you are looking for help from a financial advisor, you can contact us by clicking on the button below. We can provide you with a retirement plan as well as assist you with managing your retirement savings. Let us know how we can help you.
Do It Yourself Approach - If you are looking to do the retirement planning yourself, you should create a retirement plan which outlines all of the goals you want to accomplish and what they will ultimately cost to accomplish. I have provided you with a copy of my spreadsheet that I used to calculate my 3 methods of estimating your retirement needs. Click on the button below to get a free copy of my retirement savings spreadsheet
If you are in retirement or quickly approaching the due date, you have fewer choices than if you started early. We highly recommend that everyone have a percentage of their income go directly into retirement savings as a mandatory part of their monthly expenses. If you are forgoing this month’s savings for a new iphone, you need to fix your priorities. Retirement savings should be a non-discretionary expense for you every month. It may hurt a bit, but you will thank me later when you have a sizable retirement nest egg to enjoy in your retirement sitting on the beach.
About Innovative Advisory Group: Innovative Advisory Group, LLC (IAG), an independent Registered Investment Advisory Firm, is bringing innovation to the wealth management industry by combining both traditional and alternative investments. IAG is unique in that they have an extensive understanding of the regulatory and financial considerations involved with alternative investments held in self directed IRAs and other retirement accounts. IAG advises clients on traditional investments, such as stocks, bonds, and mutual funds, as well as advising clients on alternative investments. IAG has a value-oriented approach to investing, which integrates specialized investment experience with extensive resources.
For more information you can visit: Innovative Advisory Group
About the author: Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group. His roles at IAG are co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets. He received a BA degree in Economics from Trinity College in Hartford, CT.
Disclaimer: This article is intended solely for informational purposes only, and in no manner intended to solicit any product or service. The opinions in this article are exculsively of the author(s) and may or may not reflect all those who are employed, either directly or indirectly or affiliated with Innovative Advisory Group, LLC.