Are your retirement savings going to be enough for you to live comfortably during your golden years? A while back, Money Magazine published some great guidelines, aimed to help you answer that $64,000 question. Before we get to the guidelines, though, it is important to understand that they are built on a number of assumptions.

First, they assume you will need to replace 80% of your current, pre-tax income during retirement. If you make $100,000 now, for example, you’ll need $80,000 of pre-tax income per year during retirement. Second, the guidelines assume you will receive about $20,000 a year in social security benefits. If you would like an estimate of your social security benefits, check out this social security benefits calculator.

Third, the assumption is that you won’t receive any pension benefits (a good assumption for most of us). And finally, the guideline assumes that your retirement savings will grow by 8% a year during retirement, and that you will withdraw 4% per year to live on.

In the above example, you’ll need to replace $60,000 of income ($80,000 – social security benefits of $20,000) with your retirement savings. At a 4% withdrawal rate, you’ll need to amass $1.5 million by the time you retire ($60,000 / 4% — or if you hate division, $60,000 * 25). The 4% withdrawal rate has become a fairly accepted conservative estimate of how much you can take from your retirement savings if you want your money to last 30 years. Using a 4% withdrawal rate, simply multiply how much money your savings will need to pay you each year by 25, and you have the amount you’ll need in savings at the time of retirement.

Now at this point you may be asking why the chart started at 45. What about the Gen X kids? Having recently learned that I’m a member of Gen X, not a Boomer (barely), I feel obligated to cover the younger crowd. It turns out that this chart comes from Charles Farrell of Northstar Investment Advisors. Mr. Farrell wrote a paper back in 2006 that went into much more detail about how much savings (and debt) you should (and should not) have at various stages of your life. The complete chart from his original paper is to the right. He’s also written a detailed book on the subject, called Your Money Ratios.

You’ll note that the chart starts at age 30. You may also note that the Savings to Income ratio beginning at age 45 is different than what Money Magazine listed. So, what’s going on?

This is an important point. In Farrell’s original paper, he assumed a 5% withdrawal rate; Money Magazine assumed a 4% withdrawal rate. And if you think just 1% is no big deal, think again. At 4%, you need 15 times your pre-retirement income ($100,000 in our example) at retirement to produce 60% of this amount (remember social security covers 20%). But at a 5% withdrawal rate, you “only” need 12 times current income. In our $100,000 hypothetical, the difference in retirement savings is $1.5 million versus $1.2 million.

Which assumption is best? I don’t think there is a best here. Four percent is more conservative than five percent. The logic behind the 4% rule is that you will earn 8% a year with a relatively conservative mix of stock and bond investments. Four percent stays in savings to keep up with inflation, and 4% comes out to pay for your living expenses.

So, seeing what you make now and what you think you will need to live comfortably later on… are you saving enough for retirement?

Either I’m missing something, or the math is wrong here somewhere. Above, you state that if you withdraw 4% annually, you’ll need 15 times your pre-retirement income, but if you withdraw MORE (5%) you’ll actually need LESS at 12 times your pre-retirement income.

Shouldn’t that be the other way around? If you take more out each year, don’t you need more to begin with?

Deamiter, great question. In both cases, the assumption is that your return on investment after the withdrawal will be 4%. Four percent is used as an estimate of inflation. So with the 5% withdrawal rate, the assumption is an overall portfolio return of 9%. Many believe 9% is unrealistic for a retirement portfolio, which is why they lower it to 8%, thereby lowering the withdrawal rate to 4%.

How should I have saved by now if I’m only 24? There was not an equation for people younger than 45. I’m trying to get an early start on saving for retirement.

Stephen, great question. According to the chart in the original paper, at 30 you need a savings to income ratio at .1. So at 24 the savings to ratio would near 0. Of course, beginning to save in your 20s is probably the single most important factor in determining how well off you’ll be years later. I’m working on a second article that tackles the “how much do I need to save retirement” question from a different angle, which may help better answer your question.

I liked the article, but I have an unrelated question. What city was that picture taken?

I have been there, but can’t figure out where that thumb sticking out of the ground art is?

Rob, the giant thumb is in Paris.

Can’t I just figure out my monthly budget, add some fun money, factor in inflation and use that as a target for my retirement income? 80% of my income would be more than I live on now. Should I expect to need more when I am older in case I have health or other issues? I am 35 and I have 70k in my 401k, I feel like I can slack off on my retirement savings a little. Maybe I am under-estimating?

Daizy, I agree that not everybody needs 80% of pre-retirement income. I know I don’t. If you know how much you’ll need before taxes, multiply that number by 25 for a somewhat conservative estimate of the retirement savings you need. I’ve excluded social security, which I don’t rely on in my planning, but you may want to.

If I follow those tables I save too much. Instead I’d say save as much and as early as possible. If you are saving “too much” but are still happy with your quality of life then there is no harm and lots of future gain. I also want to replace 100% of my income and not depend on Social Security either. My proposed rule of thumb, save till it hurts when you are young and hold that percentage as you get older. For me that is 20% of my gross (not including the 401(k) match). In a few years that will be enough to max a 401(k) at $15,500 and a Roth IRA at $5,000.

Fantastic post. We cited it in our Sunday Review as one of our favorites.

Keep up the excellent blogging.

Cheers,

FIRE Finance

How do these calculations account for inflation? Unless I have a fundamental misunderstanding of how money works my annual income needs will double every 23 years. That is based on 3.1% inflation and the rule of 72. That means that the total I need to save increases dramatically. Since I reach 67 in 30 years I figure I will need 130% more total in savings than your calulations predict. Also that means that I will need to take out a slightly higher percentage of the total each year once I do retire. Is there a way to account for this?

Mark, great questions. Here’s how it works. The 4% withdrawal rate in retirement assumes that your investments will earn about 8%. You’ll take out 4% and leave 4% to cover inflation. The next year you’ll still take out 4%, but it will be of a slightly higher amount (assuming no market declines) due to the 4% you left in from the prior year. As for current savings, it assumes you get pay increases that match inflation, so the amount you save goes up each year, even if your savings rate stays the same.

Most of the studies I have seen on the 4% strategy are not the quite the same as you describe. Everything is actually based on year #1 withdrawal amount. If you have 1,000,000.00 portfolio you will withdraw $40,000 in year #1. In year two you add inflation to the amount you initially withdrew. Example inflation rate is 3%. You would $1200 to $40,000 and withdraw $41200.00 in year two. In year three is inflation is 3% you add 3% of the $41200.00 which is $1236.00. So in year #3 you would withdraw $42,436.00 ( $41200.00 + $ 1236.00) and keep doing that for the next 27 years or so. Note that there is also done doubt as to whether the 4% rule is still viable. Vanguard as has done a study and revisited the 4% rule: https://personal.vanguard.com/pdf/s325.pdf

Rodger, you are right that must studies adjust for inflation, including the rule of thumb described above. I do wonder how necessary that will be for many in retirement. Of course, if we live 30+ years in retirement, adjustments will have to be made. But in our working years, many of us go without a raise for years and do just fine. Thanks for link to the Vanguard study. It’s an excellent resource.

is the 12% pre-tax (gross pay) or post-tax (net pay)?

I’m sure I’m going to sound quite silly here and maybe I’m just bad at math, but I don’t quite understand how you would actually save this amount of money. I mean, this is assuming you’re saving 25 years worth of your annual income but how can you save 25 years worth of your whole income if you’re living. I’m obviously not understanding something or how this all works. I’m 32 and need to start saving but I don’t know where to begin! For the first time in my life I’m not paycheck to paycheck and I want to take advantage of saving for my future but I’m so confused. I was thinking it would just be like “oh put 10% of each paycheck into savings” or something along those lines. I haven’t even gotten started on IRA’s. Please help! Thanks!

Randee, saving 10% is a great start. The article looks at how much you’ll need at retirement based on (1) how much of your pre-retirement income you’ll need in retirement and (2) your withdrawal rate, that is, how much of your retirement savings you’ll spend each year in retirement. How much you save each year of course determines how quickly you reach your goal. I view 10% as a minimum, 20% as ideal, and 30% or more for those who want to retire “early.”