HOW MUCH RETIREMENT SAVINGS DO I NEED?

June 2005

This is one of the most common retirement questions we get.  The answer is largely dependant on how much of your pre-retirement income you wish to have in retirement.  If you want to live as well in retirement as you did beforehand, there are surprisingly large numbers later in this article.

We suggest you assume that you will need as much income in retirement as before retirement.  No one really wants to reduce their standard of living.  Replacing one's pre-retirement income in retirement conflicts with the conventional advice that you might be happy with as little as 70% of your pre-retirement income.  It is true that you will likely have fewer costs for employment-related expenses and taxes (the tax comment assumes you are not heavily relying on pension plans, IRAs or 401(k)s, all of which require tax on distributions).  However, you will likely spend MORE on travel, hobbies, health care, and assistance with tasks that are too physically demanding to accomplish when you are older.

Most people incorrectly believe that Social Security will provide significant retirement income.  Social Security was never intended to be more than a safety net.  Even worse, Social Security benefits will likely be curtailed in order to keep the system solvent and tax increases modest.  Even without Social Security benefit cuts, Social Security will likely replace:

• 10% or less of income for those above the FICA wage base
• Around 20% of income for those with incomes below the FICA wage base but above median income
• Around 35% of income for those with below-median income

Edmund Cannon, an economics professor from the University of Bristol in the UK, and JP Morgan announced research that simplifies complex calculations of how much retirement assets are needed.  The amount needed to replace all of your pre-retirement income is:

Current Income times (55 less (i) one-third of your current age and (ii) one-seventh of your retirement age)

This is a rough calculation, but it requires only three pieces of information and requires only seconds.  The result from this formula is a future value.  This means that (i) future amounts must be larger because of the loss of purchasing power caused by future inflation, and (ii) one can use future investment returns to achieve the amount.

Do the math for your own situation, and you will likely be surprised by how much you will need.  For example, a 40-year old making $70,000 and wishing to have this full amount without Social Security requires approximately:

• $2,267,000 at age 65 (at which point this money will have considerably less purchasing power).  This is calculated as $70,000 times (55 less 40/3 and 65/7)
• $2,517,000 for a retirement today, calculated as $70,000 times (55 less 40/3 and 40/7)

Based on Monte Carlo modeling (which involves way more math than most people want to see), our firm and other like-minded investment advisors suggest that those at a normal retirement age spend no more than around 4% of their nest egg each year.  Stated otherwise, an age-65 retiree should have around 25 times annual consumption (1 divided by 4%) in investment savings at retirement.  This result is consistent (before future inflation is considered) with the formula described above from the British researchers.

Most people do not have anywhere near the amount they need.  According to a June 2005 study by Fidelity Investments, the typical working household will be able to cover less than 60% of their income after including all Social Security and pension plans.  Only 15 percent of households will likely have 85 percent of their pre-retirement income.

Fulcrum is a Registered Investment Advisory firm.  We have a variety of free calculators that address various retirement issues.  These calculators include a Retirement Planner Calculator that calculates whether you will have enough retirement savings based on your inputs for savings, spending rates, investment returns, and other variables that you specify.