Fidelity says to save 8-times your salary for retirement but these seven retirement X-Factors could change how much you need
How much do you need to save for retirement?
It’s the million-dollar question in retirement planning…sometimes with a million-dollar answer.
Planning for something 20 or 30 years into the future isn’t an easy task. It seems like a simple question but there are so many things we just don’t know.
What does retirement look like for you and how much will it cost? How much do you have saved now and how much can you put away each year for retirement? When will you retire and what kind of return will you get on your investments?
It’s enough that most retirement savers give up on any kind of a plan. They put a couple thousand in an account each year and hope it will be enough.
I don’t know about you, but I’m not leaving 30 years of my life up to ‘hope’.
Fidelity has created a simple rule-of-thumb for your retirement number, suggesting savers grow their next egg to 8-times their ending salary. I was a little skeptical when I first saw the rule, it seemed extremely low considering most will be withdrawing on their retirement savings for two decades or more.
How does the 8x number work for you and will it be enough to meet your retirement goals?
Where Does the 8x Retirement Savings Number Come From?
Let’s look at an example to see how the 8x retirement savings number fits with how much you should save for retirement.
Jamie is 25 when she starts saving for retirement and plans on working until she’s 67 years old. Her salary is $40,000 and will grow to $73,640 at retirement assuming a 1.5% annual increase.
That means she would need about $590,000 to retire on in 42 years.
Fidelity assumes her retirement living expenses are 85% of what she spent before retiring, a common assumption. Backing out what she was spending pre-retirement and using the 85%-rule means her post-retirement spending is around $48,000 a year.
Fidelity reasons Jamie can get to her retirement magic number by investing about 10% a year from her salary and getting the 3% company match on the 401(k) plan. They assume a 5.5% return on investments which includes a 2.3% rate of inflation.
Fidelity also assumes that she will retire on $1,918 a month from Social Security. This would be a growth of 0.8% annually on the average $1,360 SSI payment received currently by retirees so not outside the realm of reason.
Accounting for social security means Jamie needs to withdraw approximately $25,000 from her retirement savings each year. That means taking 4.2% from the $590,000 estimate we got from her 8x retirement goal.
These are all pretty reasonable assumptions.
But how do these assumptions change for YOU? How do you find how much you need to save for retirement, especially if you’re not 25 years old and making $40,000 a year?
Use these seven questions to determine your retirement magic number and how much you need to grow your nest egg.
What’s Your Retirement Number X-Factor?
Start with the four factors over which you have the most control including,
- Retirement Target Age
- Percentage of Salary You Invest
- Post-Retirement Expenses
It’s important to start with these four controllable retirement factors because later you’ll have to deal with three factors with which you’ll have less control.
What Age are You Starting Retirement Investing?
The earlier you can start saving for retirement, the better. Jamie only needs to save about 10% of her salary to reach her goal because she has 42 years left to grow her nest egg. Some of us aren’t that lucky but it doesn’t mean we can’t get started.
To catch up on your retirement number, you’ll have to save more each month. An investment of $50 a month grows to $87,000 by age 65 if you give it 30 years. Wait until you’re 35 years old and you’ll need to save $94 a month to grow the same amount.
Saving 8x your ending salary by the time you retire is still achievable even if you’re starting in your 30s. Wait until any later and you might have to make due with 7x or 6x your salary.
What Age Do You Want to Retire?
The age at which you decide to retire plays a big factor in how much you’ll need to pay expenses. Waiting to retire at 67 instead of 63 not only means four more years of saving but also that your retirement investments will grow over the period.
You also benefit from higher monthly social security payments. Those born after 1960 can start taking retirement benefits at age 62 but will only get 70% of their monthly benefit. That means an average check of $952 per month.
Waiting until age 67 means an extra $400 a month in today’s dollars and you get more money for every year you wait. Waiting to retire at 70 means an extra $435 a month (32%) on top of the current average SSI payment. The detail on how much your SSI check grows for each year of delayed retirement is available here.
That doesn’t mean you have to wait that long to retire. If you’ve put money away since you started working then there’s no reason you can’t retire early and may not even have to count on social security.
But it’s nice to know that a few more years of work can really help if it took longer to start saving for retirement.
In fact, saving just $3,000 a year and waiting until 70 to retire can still provide a great income even if you wait until 35 years old to start saving.
You can’t always control when you choose to retire. Health and job availability may mean a forced retirement and could seriously cut into your plans. This makes it even more important to start saving as early as possible and to save as much as you can, while you can.
Getting the Most from Your Paycheck
This one isn’t necessarily a retirement savings factor but will help you find more money to put away for retirement.
The Bureau of Labor Statistics reports that the average American saves just 4% of their income. That’s not enough to meet your retirement spending needs no matter how early you get started.
Shopping is fun and saving is hard. I get it. You know what else is hard, living on less than $15,000 a year in retirement.
Saving more means finding ways to stretch your paycheck. Two of the best ways to do this are with Health Savings Accounts (HSA) and 529 College Plans. These are some of the best tax-free savings options you can get and really help to save you money for retirement.
An HSA is an account you fund straight from your paycheck before taxes to cover medical expenses. Since the money comes out before taxes, it’s like saving 15% or more on your healthcare bills.
Even if you’re not spending much for healthcare now, there’s no time limit on using the money. It grows tax-free while in the account and is tax-free on withdrawal if used to pay medical expenses.
A 529 plan is similar except used to pay college and other post-secondary expenses. You don’t get a tax break on your federal income taxes but you might save on your state taxes and the returns are all tax-free if used for education.
Using these two special tax saving accounts can help you increase your 401(k) contribution. I showed in a previous post that saving just 1% more each year can mean thousands more in retirement income.
If your employer caps the amount you can contribute to your 401(k) plan and the match, consider saving additional money in an Individual Retirement Account. These offer the same tax-free benefits of an employer retirement plan plus you get more control over your investments.
How Much of Your Pre-Retirement Income Do You Need?
The rule of thumb for post-retirement spending is 85% of your pre-retirement ending salary. There are a few reasons I disagree with this estimate and some ways you can change it depending on your needs.
First, your ending salary is meaningless in retirement. You need to base your retirement planning off living expenses.
If you were saving 15% of your salary for retirement then you were already only spending 85% of your salary before you retired. Beyond that, your expenses will probably decrease during retirement.
But you won’t know until you sit down and actually PLAN for retirement.
I see too many people pull a number like $1 million out of their…lower region, for how much they need for retirement. They start saving but then get discouraged because retirement is just some obscure concept.
You need to make retirement real and something for which you can get excited about if you’re ever going to reach your goals.
- Visualize your daily life. Where will you be and what will you do?
- Visualize the special things you’ve always wanted to do.
- Create a budget based on what retirement means for you
Not only will this help you find exactly how much your living expenses will be in retirement, you’ll be motivated to get there because you’ll have a mental picture you carry with you.
You can use this estimate for retirement costs along with other factors like how much you think you’ll be earning before retirement to change your retirement X-factor higher or lower. You may find that you need much less than 8-times.
What Return Can You Expect on Your Retirement Investments?
Here we get into some of the retirement planning factors that are more difficult or impossible to control. There are ways to guide these factors but you’ll never have complete control like the previous retirement X-factors.
Too many people plan their retirement investing based on the stock market’s historical return.
Big mistake…like huge!
While the stock market has provided an average 8% annual return over the last several decades, that’s far from the return you’ll get on a diversified portfolio. A portfolio of stocks, bonds and real estate has earned closer to 6% over the last 30 years.
Why not go for the big win with all your retirement investments in stocks?
How about losing half of your next egg during the next stock market crash? How about freaking out when stocks begin to stumble and panic-selling at the worst possible time?
Despite strong stock market returns over the long-run, the average investor has made just 4.6% annually because of bad investing behavior during stock market swoons according to DALBAR research.
The solution is a smart plan for investing according to your age, something I detailed on my investing blog. Younger investors can start with higher percentages in stocks with less in safety assets for protection. As you get closer to retirement, shifting money into bonds will protect your nest egg but still provide for a reasonable return.
I recommend using an estimated 5.5% return in your retirement planning. You can revisit your plans every five years to see how much you have saved and may find you’re earning more than expected.
How Fast Will Your Salary Grow Before Retirement?
I had a high school teacher that was fond of saying, “Show me an income and I’ll show you how to live above it.”
How true is that? How many stories have you heard of millionaire celebrities filing bankruptcy?
How fast your salary grows over the years and how your spending grows will affect your retirement planning. But should it?
Your retirement planning should be based on what retirement looks like to you, what you want to do and how much it will cost. If your image of retirement changes as your income increases then that’s one thing but you don’t necessarily need to spend more in retirement just because you make more money before it.
The problem comes from people increasing their living expectations as their salary grows. The 30-year old with a $40,000 annual income might have modest retirement plans. By the time they reach 60 years old and are making $80,000 a year, their living expenses have surged and they expect something completely different in retirement.
One of the best ways to fight this danger in retirement planning is to put more of your salary increases in savings. Aim for investing 50% of the increase in your salary each year in addition to what you were saving before.
You won’t miss the extra money. In fact, you’ll be able to increase your spending by the other half of the amount in your salary increase.
This trick will not only help you save more for retirement but will help you keep your cost of living lower so you don’t find yourself with unreachable retirement expectations.
How Long to Plan for Retirement
This last retirement X-Factor is something nobody wants to consider. How long will you live?
It’s impossible to answer. My wife’s grandmother is 85 and still very active. My father died of cancer when he was just 42 years old.
As medicine advances, we’re living longer on average. Most advisors now say women should plan on living to 88 while men should plan to 85 years old. That doesn’t mean you’ll live that long but it’s much better to have money left over in your retirement account than to run out.
Fortunately, if there is anything to consider fortunate in our own mortality, your retirement spending decreases as you age. That means living longer doesn’t quite affect the amount you need saved for retirement as much as you might think.
The BLS reports in its regular consumer expenditures survey that new retirees spend about 90% of their pre-retirement spending. That percentage decreases gradually until around 70% when retirees reach the age of 80 and then levels off.
Some other Retirement Factors to Consider
It’s a lot to think about. Nobody said planning for 30 years of your life should be easy or something you do in an afternoon. Your retirement planning is a life-long affair and something that will change depending on factors that affect your life.
Don’t feel like you have to get everything perfect to enjoy the retirement of your dreams. These are all just guides and tips to help you save enough and grow your nest egg. As your retirement plan evolves, keep these simple ideas in mind:
- Enroll in your employer-sponsored plan and max out the match
- Aim to save at least 10% or 15% but get started now with as much as you can
- Invest across stocks, bonds and real estate to protect against market swings
- Make retirement real by visualizing your goals
- Revisit your plan every few years to keep on track and check your progress
There is no magic retirement number but these X-Factors will help you get closer to how much you’ll need in retirement to live comfortably. Sit down with your spouse and make retirement planning something you enjoy by talking through the concepts and planning your life together.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.