Exactly how much should you be saving for retirement? It seems everyone has an opinion on this deceptively simple question. Actually, it is simple to answer, so long as you understand the implications of your choices.

Are your retirement savings going to be enough for you to live comfortably during your golden years? To address this question, we are going to look at the standard rules of thumb on retirement savings. But we are going to go further. We are then going to look at the math and assumptions behind the rule of thumb. Finally, we cover those difficult times where the assumptions don’t make sense for specific situations.

## Rules of Thumb

The most common rule of thumb is that families should save 10% to 15% of their gross (before taxes) pay. Fidelity, for example, recommends that retirement savings eventually hit 15% of income. Liz Weston of MSN recommends saving 10% for the basics, 15% for comfort, or 20% to escape. An article on BrightScope written by CFP James Kinney recommends 15%.

## The Math

So just how do these rules of thumb work? Why 10% to 15% versus some other number. To answer that question, let’s first look at the math. In this hypothetical example, we’ll assume the following:

- A family makes $100,000 a year
- They save 10%, or $10,000 a year
- There is no inflation, so their income and annual savings amount remain constant
- They earn 5% on their investments (remember, we are ignoring inflation)
- They save for 40 years, from age 25 to retirement at 65

With these assumptions in place, this hypothetical family will, after 40 years, have accumulated about $1.2 million in savings. Here’s the math:

Now we need to make a few more assumptions. First, we assume that in the first year of retirement our family can safely withdrawal 4% of their nest egg, or about $48,000. (You can read more about the 4% withdrawal rule.) Second, we assume that they will receive about $33,000 in Social Security benefits (check out this calculator to estimate your benefits). And finally, we assume that they can maintain their pre-retirement lifestyle on about 80% of their pre-retirement income.

## Changing the Assumptions

In the above example, you’ll need to replace $47,000 of income ($80,000 minus Social Security benefits of $33,000) with your retirement savings. At a 4% withdrawal rate, you’ll need to amass $1.175 million by the time you retire ($47,000 / 4% — or if you hate division, $47,000 * .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.

Let’s look at some common changes to the underlying assumptions that many will need to make.

### Saving for 40 years

For many people, they have waited to the point where they no longer have 40 years to save for retirement. For these folks, they may need to save more than 15% a year. There are several resources that can help you assess where you stand and what you need to do:

**Money Ratios**: In his book, Money Ratios, Charles Farrell walks through how much you should have saved based on your age and income. It’s a great way to assess where you stand and what you need to do to get back on track. I discussed his work on Podcast 31.

The chart to the left provides some guidelines. At age 35, for example, you should be saving 12% and have retirement savings equal to 0.1 of your income.

You’ll note that the chart starts at age 30. This is an important point. In Farrell’s original paper, he assumed a 5% withdrawal rate; most assume 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?

**Early Retirement**: For those late to the game, you can learn a lot from those that retired early. In Podcast 7, I interviewed Mr. Money Mustache. He retired at age 30 after just 9 years of work. The steps he took to retire young can help those who need to catch up on their retirement savings.

### Saving 10 to 15%

For those just starting out, saving 10% or more of gross income is a real challenge. In addition to paying school loans, many are starting a family and buying their first home. The key, however, is to get to this level (or more) as quickly as you can. If it seems like there’s no money left over to save, check out my One-N-Done method of saving money.

### Earning a 5% real rate of return

We can’t control market returns. But we can control several very important factors. We can control our asset allocation (with an emphasis on equities for long-term growth); we can control our investing costs, and we can control our behavior when the markets go crazy.

Five percent isn’t guaranteed. The actual returns over the next several decades may be higher or lower. But we should focus on what we can control.

### 4% Withdrawal Rate

The 4% withdrawal rate rule of thumb is commonly accepted as a reasonable approach to retirement spending. But it’s not without its detractors. Some believe future market returns will be insufficient to justify 4%. For more on this rule and its alternatives, check out Podcast 46.

The key is to evaluate the assumptions in light of your own circumstances. The answers may not be easy, particularly if you started saving late in life, but at least you’ll know where you stand and what you need to do.

**Topics:**Retirement Planning

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%.

To use an 8% or 9% return assumption when planning for anything is foolish. At most, one should be using a 6% return rate. As Buffett said in 2000, we can expect a more normalized return in the markets around 6%. Since 2000, the markets have returned 6.4%. When planning, it’s always better to keep your return expectations lower, and you expense expectations higher. If it turns out that you average 8 or 9 percent – splurge on something that year. But watch out for what’s coming he next.

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.”

Unrelated to this article,but in reference to your 1/26/17 podcast I have always invested in actively managed international mutual funds simply because there are many managers who beat the index.As oppose to domestic funds where the indexes usually out perform. the actively managed ?

I am not literally good at math. But i think if you really want to know how much saving you make that would be enough on your retirement? Just know what you want to do after retirement. Sample question would be. What kind of living do you want? Do you want to travel? Put up a garden on the backyard? Build a huge comfortable mansion perhaps? Think of what do you want to have ahead before you retire. Then you would know how much do you need to save in-order to attain that kind of living. Somehow, this article is helpful to those who don’t have that idea on how much do they need to have. Thumbs up on this one! Keep it up!