Did You Know Your Pension Isn’t Guaranteed?
Sometimes when I talk to people about financial planning, their response is ‘Oh I have...
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I’M SUPPOSED TO HAVE SET ASIDE HOW MUCH?!
How much should you have saved for retirement by now? Isn’t that something most of us would dearly love to know, so we can tell how well (or less well) we’ve done? The problem isn’t that nobody knows the answer, it’s that so many people and institutions know and are eager to tell you, but their formulas rarely if ever agree with each other! What’s a guy (or gal) to do?!
One of the most widely acclaimed popular books on wealth in the US is undeniably “The Millionaire Next Door” by Thomas J. Stanley, PhD andWilliam D. Danko, PhD. In the book, the authors proposed the following simple formula as a guideline.
Divide the age of the main breadwinner in your household by 10, and multiply by your household income (they say that your Adjusted Gross Income, or AGI, is a good number to use). For example, say John, aged 52, is married to Jane, aged 55. Say Jane’s salary is higher than John’s, and together their AGI is $90,000/year. The formula says that they should by now have $495,000 set aside for retirement (= (55/10) x $90,000).
The authors then proceed to call those who have set aside double or more what the formula suggests PAWs, or “Prodigious Accumulators of Wealth.” On the other hand, those who have set aside less than half the suggested amount are labeled as UAWs, or “Under Accumulators of Wealth.”
How did they come up with this formula? Says Stanley, “The Wealth Equation was developed from national surveys of households with incomes of $80,000 or more. The typical millionaire is in his/her late 50s. In fact, in my most recent national survey, the typical millionaire was 57. Those who are significantly younger than 57 should be aware of the fact that the Wealth Equation overstates what they should actually be worth.”
Fidelity has a different guideline. They say you should set aside at least 1x your salary by age 30, 3x by age 40, 6x by age 50, 8x by age 60, and 10x by age 67. This seems more plausible, as they don’t imply that you should start saving for retirement at birth, and Fidelity’s guideline has you setting aside more from age 45 to 50, where salaries are usually relatively high and your kids’ college expenses have yet to hit in full.
Using the well-known 4% rule, if you have 10x your last salary invested, you should be able to draw 40% of that last salary for a retirement of at least 30 years. Fidelity adds to that your expected Social Security benefit and average spending patterns in retirement vs. pre-retirement.
Kiplinger’s has a somewhat different guideline. Specifically, at least 0.5x your salary by age 30, 2x by age 40, 5x by age 50, 9x by age 60, and 11x by age 65. This is even better, because it reduces the amount you’re expected to set aside in the first few years after joining the workforce. Recognizing that different people have different situations and expectations, they also provide ranges around the above numbers. For example, 3.5x to 6x by age 50, 6.5x to 11x by age 60, and 8x to 14x by age 65.
Both of these guidelines still suffer from nearly all of the same shortcomings as The Millionaire Next Door’s formula.
As is the case with every personal finance question, an accurate answer as to whether or not you’ve saved enough given your age must start with, “It depends…”
What I’ve done for my family is this:
If you’re relatively young (in your 20s or 30s), having anything set aside for retirement already puts you far ahead of most of your cohort. If you haven’t set anything aside yet, being as young as you are gives you more time to get on a good glide path, as long as you start prioritizing your retirement savings.
Setting aside at least 15% of your annual income each year (FIRE adherents would say 40% or more!) will help you get where you need to go. If your employer matches your contributions to the company retirement plan, make sure to put into the plan at least enough to capture the maximum match.
If you’re older and haven’t set much aside, you have to play catch-up, which won’t be fun. You should start putting aside a lot more of your AGI than if you were younger. Hiring a good fee-only financial planner is a wise move, as such an advisor isn’t paid based on your investable assets, and isn’t trying to sell you any specific investment products based on how high a commission that would generate. Such an advisor can help you craft a solid retirement plan, tell you how much of your AGI you should set aside each year, and how much longer you’ll need to work, given the retirement lifestyle you want to have.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.