How Much Should You Save for Retirement? Play the Percentages

by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
March 15, 2005

Much has been written about how big your portfolio should be when you retire. For example, in Spending Confidently in Retirement we look at what size portfolio you might need to be highly confident of maintaining your standard of living over a 30-year retirement. We recommend shooting for a portfolio roughly 25 times the amount you plan to spend in your first year of retirement, minus what you expect from other sources of income such as Social Security.

For example, say you plan to spend $80,000 in your first year of retirement ($60,000 from your portfolio and $20,000 from Social Security) and you want a high probability you can keep up with inflation over 30 years. You should plan for a $1.5 million retirement portfolio (25 x $60,000 = $1.5 million).

As with any general guideline, your personal circumstances will dictate what's best for you. You may want an even higher confidence level, which means spending less in retirement and/or planning for a bigger portfolio. On the other hand, you may be willing to settle for a lower probability that your retirement portfolio will last 30 years, which means you could spend more and/or accumulate less.

How much should you be saving now?
Let's assume you like the idea of having a high probability of maintaining your lifestyle over a 30-year retirement. What percentage of your pre-tax salary¹ should you be saving now to give yourself a good chance of achieving that goal?

First, our assumptions:

No previous retirement savings—you're starting from zero. If you already have retirement savings (and you're a Schwab client), you can log in and use the Schwab Retirement Planner to run your own numbers.
You plan to spend 80%² of your pre-retirement, pre-tax income in retirement, adjusted for inflation and highly likely to be sustainable for roughly 30 years (assumes retirement at age 65).
Social Security or other income will provide 25% of your retirement income needs each year. Your portfolio will have to provide for the rest of your spending needs in retirement. (We assume a conservative-to-moderate portfolio allocation in retirement, with no intent to leave a portion of the portfolio to any heirs.)
Your pre-retirement income will grow (at least enough to keep pace with inflation) during your working years.
You average a compound annual return of 8% on your pre-retirement investments, with 2.5% inflation.

Given these assumptions, here are some broad guidelines for the percentage of your salary you should be saving each year for retirement. These are minimum targets—if you can save more to increase your probability of success, all the better. Remember, this assumes you have no retirement savings thus far.

Saving for retirement

Age when saving starts	% of salary to save each year
20-something	10%-15%
30-something	15%-25%
Early 40s	25%-35%
45 and older	OUCH! See Play the Percentages: 45 and Older

Once you start, the same savings goal applies until you retire. In other words, if you start saving roughly 12% of your income in your mid-20s and have the discipline to maintain your savings plan, you shouldn't have to increase that percentage as you go through your 30s, 40s and so on.

That's the benefit of getting an early start saving for retirement: The lower-percentage savings guideline stays with you the rest of your working life, if you can stick with it. The later you get started, the higher the percentage of your income you'll need to save.

Advantages of saving a fixed percentage of your pre-retirement income

• It's easy to implement through your 401(k) or other employer plan (any employer match will help as well), up to the plan's annual limit. Additional savings can go into your IRA or brokerage account.

• Assuming your income grows over time, the dollar amount you save will automatically grow as well.

Of course, the paradox is that during our 20s, when we can lock in the lowest savings rate, we're not thinking about retirement. We're paying off student loans, saving for our first home, buying furniture and home entertainment systems, and generally having fun. Then, by the time we get past that stage and start getting serious about the future, we've grown so comfortable in our lifestyles that the percentage of income we need to save seems beyond our reach.

Don't despair
Depending on your age and how much you've managed to save so far, these percentages may have you either laughing or crying out loud. If it's the latter, remember that the purpose is not to demoralize by presenting unreachable targets. However, the numbers are what they are, and when it comes to your retirement, ignorance is not bliss. Knowledge, on the other hand, can be a powerful thing if it leads to action.

That may bring little comfort if you're still young but struggling to meet your current expenses, or if you're older and face a seemingly unattainable savings goal. A lecture about discipline and living below your means may be the last thing you want to hear. However, while magic solutions may be in short supply, there are steps you can take to improve your chances for a secure retirement. Click on your age group for a closer look at what you can do.

Stay flexible
General guidelines are all well and good. But if you're truly concerned about your ability to achieve the retirement of your dreams (and you should be), you should analyze your particular situation in more detail to figure out what makes the most sense for you. Get some help if you need it and revisit your plan regularly to make sure you're on track.

It may not be easy, but retiring with peace of mind is worth the effort.

1. We use pre-tax salary for three reasons:

Pre-tax salary is a familiar benchmark. For example, if you're earning $75,000 per year and that's enough to cover all your expenses plus taxes—even after you save 20% off the top—you might figure you can maintain your lifestyle in retirement on pre-tax income of $60,000 (adjusted for inflation).
The bulk of your retirement income will likely be withdrawals from tax-deferred accounts, which are subject to ordinary income tax. So, a projection based on pre-tax income before and after retirement is an apples-to-apples comparison for the most part. To the extent you're in a lower tax bracket in retirement and/or withdrawals come from a Roth IRA or long-term capital gains in taxable accounts, you'll be that much further ahead after taxes.
Employees typically select a percentage of their pre-tax salary to contribute to a 401(k) or other qualified employer retirement account—which makes a pre-tax savings goal easier to achieve.

You can always perform a more detailed, after-tax, line-item budget analysis and projection if you like.

2. For people 40 or older who have not yet started to save, the retirement spending goal is 70% of pre-retirement, pre-tax income—a higher level would require an unreasonable percentage of current savings.

The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information should not be construed as an offer to sell or a solicitation of an offer to buy any security. The investment strategies and the securities shown may not be suitable for you. Investors should consult their own tax and investment advisors about their specific situation prior to taking action based on this article. We believe the information provided is reliable, but Charles Schwab & Co., Inc. ("Schwab") and its affiliates do not guarantee its accuracy, timeliness, or completeness. Any opinions expressed herein are subject to change without notice.

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