The “save 10% for retirement” rule is absolutely stupid. And so is “save 15% for retirement” (sorry, Dave Ramsey) or “save 20% for retirement” and any other “save #% for retirement” rule you’ll come across. Now I don’t doubt that the people giving this advice meant no harm. They probably just want to get you to start saving for retirement, and offering a simple % of your income solution is a quick, easy answer for a difficult question.
But they’re all absurd, useless rules for one simple reason: they completely ignore your situation. For most people, a simple rule like “save 10% of your income for retirement” is likely to be wrong (and blindly following dumb advice like that can have nasty results). The right answer depends on seven major factors that are specific to you and your situation. Specifically, they are:
- Your Current Age
- Your Retirement Age
- Your Life Expectancy
- Your Current Savings
- Your Investments
- How Much Income You Need for Retirement
- Your Current Income
All of these factors work together to determine how much you should be saving for retirement each year. Let’s break them down.
Your Current Age & Retirement Age
The difference between your retirement age and current age determines how long you have to save and invest. If you’re 25 now and don’t plan on retiring until you’re 70, then you’ve got 45 years until retirement. But if you’re 50 and want to retire at 65, well then you’ve only got 15 years. That’s a huge difference!
The longer you have until retirement, the less you’re going to have to save. But these simplistic rules ignore this completely. If you’re young and just starting out, these rules might be OK for you. But if you’re older and haven’t done so well with saving for retirement, you’re not going to be happy when you realize you can’t retire because you didn’t save enough.
Your Life Expectancy
Trying to guess your life expectancy can be a shot in the dark. You don’t really know when you’re going to die. But your health, your habits, and your family history do affect how long you can expect to live. Obviously, the longer you’re likely to live, the more you should save for retirement. But these dumbed-down % rules don’t account for this at all.
Your Current Savings
If you’ve been wise and have already been saving a lot for retirement, you may not need to save 10% of your income. But if you’re 50 years old and haven’t saved a dime, then even 15% or 20% are unlikely to cut it unless you’re willing to make some major changes to your life and retirement plans. How much you already have saved can drastically affect how much you should save for retirement, but once again these % of your income rules won’t help.
Are you so afraid of risk that you’ve vowed only to use CDs to save for retirement? Well, I can tell you that you’re going to need to save a whole lot more than 10% of your income even if you’re starting at 18 and don’t plan to retire until you’re 75. Your investment returns (which are connected to the risk you’re willing to take) will drastically affect how much you need to save. Based on what I can figure, the % rules assume you’re going to invest in a moderately aggressive mix of stocks and bonds that you tone down as you get closer to retirement. So if your risk tolerance is higher or lower, these rules won’t work for you.
How Much Income You Need for Retirement
How much income you need for retirement is also a huge factor in figuring out how much you should be saving. Are you going to get a pension? Well, you’ll need less income from your own savings (lucky you). Do you plan to downsize and cut way back on some major expenses? Then you probably won’t need to save as much. Want to travel the world extensively? You might have to plan on saving more if your retirement expenses are going to drastically exceed your current income.
You see, these % rules assume you’re going to need about 80% or so of your income in retirement. (That’s a stupid assumption for some other reasons, but I’m saving that for a different post.) So if you’re going to be different, these rules just won’t work for you.
Your Current Income
Finally, and this should be obvious, your current income will affect the % you should be saving. Once you consider all these other factors I mentioned above, you can figure out exactly how many dollars you should save for retirement this year. But depending on what you make now, that could be 5% or 25% of your current income. (Or even more!)
So how, exactly, should you calculate how much you need to save for retirement? Well, I’d like to say that my handy little retirement calculator is the perfect answer, but it’s not. (It’s free by the way!)
My calculator assumes you’re going to invest using a diversified portfolio of low-cost index funds (also a free calculator) with a moderate-slightly aggressive stock/bond mix. It also simplifies the taxes and doesn’t allow for “lumpy expenses” or significant changes in your retirement spending. Finally, it’s based on some other assumptions that I just can’t know will be absolutely correct. I did my best, but I know it’s not perfect.
My free retirement calculator is certainly an improvement over these stupid % of income rules, but it’s still no replacement for sitting down with a good fee-only financial planner and working it out. So definitely try it out, but do yourself a favor and find a qualified professional to help you as well. And you need to do this more than once. Every few years you should revisit this plan with your advisor and update it as needed.
I know that’s not an easy answer, but at least you’ll have a better chance of actually meeting your goals! Plus, I tried to make my calculator as simple as possible without making it too simple. And trust me, it’s better than most of the other free retirement calculators you’ll find out there because I used hundreds of thousands of Monte Carlo simulations to develop it. So it’s based on assumptions that mimic real market returns (which vary from year to year) instead of assuming a straight % return every single year (like 8%, 8%, 8%, …).
Try it out, let me know what you think, and feel free to share your results here! What % of your income should you actually be saving to reach your retirement goals?
(photo credit: Nina Matthews)