Thursday, November 15, 2012

How Much to Save for Retirement – Part 2

Having possibly shocked you in my previous blog by showing you the hundreds of thousands of dollars you need to save in total to maintain your standard of living after you retire, we can now proceed to how much of each monthly paycheck you need to save to accumulate that much wealth.

I wish I could tell you it’s a more appealing story.

Perhaps you believe that the 6% you stash in your 401(k) plan is enough. Unfortunately, that isn't the amount you need to save, it's only the amount that the Federal government allows you to save in a tax-deferred retirement savings account.

Starting with the same approach I used to look at total savings required, let’s first look at the retirement savings rate guesstimates of a few experts. Let’s assume you will need to replace 50% of your pre-retirement income from personal savings and Social Security retirement benefits will replace the rest. (That’s a good assumption in the $40K to $60K income ranges. You would need fewer savings with lower salaries and more at higher.)

Table 1. Estimates of Retirement Savings Needed 
(Percent of income, including any company match.)

Start Saving at Age:
Aon Consulting
Forbes magazine

Trust me, you don’t want to know.

Because savings balances grow exponentially, beginning to save past age 35 requires you to save an enormous chunk of your take-home pay. Pfau, for example, estimates that if you begin saving at age 45, you’d need to save about 36% of each paycheck. So, I’ll stop my table at age 35 and simply say that if you start saving much later than that, you’re probably screwed.

Given that we need to save somewhere around 15% of our take-home pay every year of our careers until our mid-60’s, how much are Americans actually saving?

It depends on your income level, of course. If you make lots of money, it’s easier to save lots of money than if you’re scrimping by to pay the mortgage and help a kid through college. But, here are the averages according to an Aon Consulting study.
Nothing close to 15%, right? Not even for high-earners. And those numbers are for workers who have a 401(k) plan. About half of workers are saving nothing at all for retirement.

Conservatives love to say, “Boomers didn’t save enough”, but a study from the Employment Benefit Research Institute shows that Gen-X’ers are even less prepared for retirement. And according to financial guru William Bernstein,

The last cohort [demographic group] that actually was able to make their number started their careers in 1980, and they made their number in 19 years. And the graph ends in 1980, because no cohort that started work after 1980 actually made the number.”

My favorite Bernstein quote on saving for retirement, and the best advice you will receive anywhere on the subject, comes from his book, The Investor's Manifesto, in which he says,

"First, save as much as you can, start as early as you can, and don't ever stop."

The fact is only wealthy people can save at rates like these. Our current retirement system is failing us miserably. But this blog is for the unwealthy, so stick with me and I’ll explore what you can do to make the best of a bad situation.

You can get more information from my book, Retiring WhenYour 401(k) Fails.

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