What Percent of Your Salary Should You Save For Retirement?

Note: If you're looking for the quicker, ballpark, estimate of how much you'll need to save, see the easy-to-use graphs in What Percent of Your Salary Should You Save For Retirement? (by starting age, with Social Security), percent to save at higher incomes, or without Social Security.)

"What percent of my salary should I save?" is a frequently asked question -- especially early in one's career. People often ask the question implicitly assuming there is a standard, magic percentage of your pay that works for everyone. I think the most honest answer is "it depends." In this post, we'll add some additional capabilities to my retirement calculator so that you can understand what the answer depends on and use the calculator to determine a percentage that works for you. (The download link is at the end of the post.)

Pat's Retirement Savings Plan

In How Much Money Will You Need To Retire?, we looked at a hypothetical 25 year old, Pat, who wants to retire at age 65 and have $45,000/year in today's dollars for after-tax living expenses (not income) during a 20 year retirement. The retirement calculator introduced in that post estimated that
Pat would need more than $2 million in tax-deferred funds at age 65! (See that post for a discussion of the assumptions made; you may need to accumulate considerably less -- especially if you expect to spend less than Pat, or you expect to have a pension, or....) The graph above (click to expand) suggests that by saving and investing 10% each year, this 25 year old could accumulate the needed retirement funds -- and then some; the final total is over $2.3 million.

Keys to Successful Retirement Saving

Three of the most important factors in reaching your retirement savings goals are:

• How much you contribute,
  
• When you start, and
  
• How much your investments earn

Clearly, the greater the percentage of your income you save and, the more you are likely to end up with. The general consensus is that 10% is usually the minimum starting point. Many people find that as they get older they are able to contribute significantly more. (See link at bottom of post for a fascinating discussion of how much other people are saving.)

The longer your money is working, the more it is likely to earn. By starting early, Pat is allowing 40 years for "the magic of compounding" to do its thing. Had Pat waited until age 35 it would have been considerably more difficult. (See Start Investing When You're Young)

The greater your return on investment (ROI), the more you will accumulate. Pat is assuming an ROI of 8%, the default assumption of many retirement planning calculators. Note, however, that it is your actual, not your planned, returns that ultimately matter. Be realistic; some of the links at the end of the post may be helpful in that regard.

From the above we can see that the percent of your pay you need to save clearly depends upon, at a minimum, when you start, and how much you earn on your investments. Start early and earn a substantial return, and you won't have to contribute as much. Even in the best of circumstances, however, you'll likely need to save at least 10%.

The Impact of Inflation

In Pat's case, there is another important factor that makes it much easier to accumulate $2 million than you would expect -- inflation. We've assumed that Pat is making about $65,000 a year. The savings needed are more than 33 times Pat's current salary; that sounds like a lot. However, in 2049, if Pat's salary keeps up with the assumed inflation of 3% per year, Pat's salary will be over $200,000! As a result, when Pat retires, $2 million dollars may "only" be a little more than 10 years salary.

Al's Retirement Savings Planner Assumptions

Note: Click on the screenshot below to expand it. The link to download the spreadsheet is at the end of the post.



In the previous post, we saw that the amount needed for retirement depends on a surprising number of factors. When basic retirement planners calculate your planned savings, the results depend on a similar number of factors. Above are the inputs used by this model. It follows that the percent of your income you'll need to save also depends on factors such as how much money you start with (do you have a trust fund from a rich uncle?), and what percent of your savings are being matched by your employer.

Observations About Traditional Retirement Savings Models

Traditional savings models make the same simplifying assumption about return on investment (ROI) as we made when calculating needed savings. That is, they assume you will earn a constant return year after year. However, the fact that it's an unrealistic assumption is less of a problem here. That's because, assuming you update your plan every year or two, your estimate of how much you will have at retirement will become increasingly accurate. That doesn't mean you'll like the results, but at least you'll have the opportunity to do something about it if your plan is diverging too far from your target. For example, you could increase your annual savings during the remaining years; or, you could defer retirement until you've met your target.

A note of caution. So far we're only talking about saving for retirement. Many of you will also have to deal with saving for other important goals -- for example, buying a house, or sending kids to college.

How Much Should I Save For Retirement: Conclusion

In order to have a reasonable chance for a comfortable retirement, most people will need to plan to save a large sum of money. It's not as difficult as you think. However, there is no magic percent of your salary that works for everyone. Start early and you may be able to get by with 10%; wait 'till your mid-30s and you may well need to stash away 15% or more.

Note, however, that how much you'll want to save depends first upon what your situation will be after you retire.  For example, how much do you plan to spend?  Will you have a pension and social security? Those questions are addressed in the first post in this series. Retirement tools like this Excel spreadsheet can not only help you figure out how much you'll need to save to support your desired lifestyle, but also help you devise a plan to save it. The next post in this series will help you put together a consolidated savings and spending plan.  Remember, the earlier you start planning the easier it will be, and the better your chances for a comfortable retirement.

Related Materials:

My SIMPLE Retirement Savings Calculator: a simpler, "back-of-the-envelope" interactive calculator that calculates how much you need to save using the same concepts used to produce the graphs linked to at the top of this post.
How Much Money Will I Need To Retire? discusses the "needed savings" portion of the spreadsheet discussed in the current post.
A Retirement Planning Calculator/Spreadsheet includes a link to the completed traditional retirement planning spreadsheet showing the accumulation and distribution of retirement savings (version 3).
Start Investing When You're Young: graphical demonstration of the impact of starting early.
For a little perspective on historical stock market returns, see
Average Annual Returns Since 19xx, and
Range of Stock Market Returns for 1-100 Years
Do You Need a Personal Strategic Plan? to help you set goals and establish priorities.
Curious about how much others are saving? See this fascinating discussion thread.

Link to Spreadsheet

Here's the link to download the Excel spreadsheet: The Observations Retirement Planning Spreadsheet (version 2). If you have any problems accessing or using the model, see this post.

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Copyright © 2009        Last modified: 12/3/2012