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Adjust Savings Rates as Income Rises

An adjustable approach to retirement savings may improve the odds of success. Researchers at Dimensional Fund Advisors suggest workers adjust their savings rate as their income increases over the span of their careers.

A worker who consistently saves from age 25 until retirement at age 66 will need to put away 16.8% of his salary annually to replace 40% of his preretirement income with a 95% probability. Their suggested savings rates include employer contributions. The portfolio allocation used is a mix of global equities and fixed income. The allocation is adjusted annually based on the exposure to stocks equaling 120 minus the worker’s age.

Changes in age or the savings rate alter the equation. A worker who starts at age 30 will need to save 19.5% of his income, while a worker who starts at age 35 will need to save 23.8% of his salary to achieve a 95% probability of having enough to adequately replace his income in retirement. A 35-year old who saves 19.2% of his income instead will see the probability of having enough in retirement decline to 90%. At an 8.7% savings rate, the probability of success falls to 50%.

Changes in income also alter the outcome. The researchers calculated the highest failure rates of not meeting the target income replacement rate among households with steep income growth. This necessitates a change in savings rates as income rises. For example, a 25-year-old making $48,000 can start by saving 6.6% of his salary. When he reaches a peak income of $120,000 by age 45, he should save 17.6% of his salary. Doing so will give him a 90% rate of success.

Across income levels, savings rates for a 90% chance of success range from 4.4% for those earning between $25,000 and $40,000 to 11.0% for those earnings between $60,000 and $70,000 to 26.4% for those earning in excess of $180,000 per year. The rates for a 95% probability of success are 5.7%, 14.2% and 34.0%, respectively. These are not static levels, but rather suggested ranges workers should adjust their savings rates to as their incomes rise over time.

As far as determining whether savings are on track, the researchers suggest dividing accumulated assets by current income. An asset/income multiple of 7.5 at age 55 implies a 90% success of having enough savings to replace 40% of income in retirement, excluding the additional amount provided by Social Security benefits.

Source: “How Much Should I Save for Retirement,” Massi De Santis and Marlena Lee, Dimensional Fund Advisors, June 2013.


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