A Universal Guideline for Saving for Retirement

How much do you need to save for a financially secure retirement? The answer differs for each investor, but there is a guideline that can be universally applied.

The most effective way to achieve financial security in retirement is to consistently save throughout one’s career. The challenge is knowing how much to save. Daniel Gardner of Russell Investments says the answer differs for each investor, but there is a guideline that can be universally applied.

The guideline is based on the amount of income a retiree needs to live, also referred to as the replacement rate. This is the percentage of final salary a retiree will need to live on and is composed of Social Security benefits, pension payments and retirement withdrawal rates. Mathematically, the replacement rate is income needed for anticipated spending in retirement divided by the final year’s salary. Russell Investments’ guideline is based on target replacement income (TRI). TRI is the percentage of pre-retirement gross salary needed to maintain inflation-adjusted spending in retirement exclusive of Social Security benefits. In other words, what percentage of final gross salary is needed after Social Security benefits have been accounted for?

Russell Investments says that a total savings rate of between 12% and 18% (including any employer matching contributions) over a 40-year period is required to achieve a better-than 90% success rate of having a TRI between 40% and 60%. The guideline is based on the “TRI 30” approach, which states that workers should target saving 30% of the TRI each year. A person seeking a 60% TRI would have to set aside 18% of gross income (0.60 × 0.30 = 18%).

Several factors determine whether the targeted savings rate should be adjusted up or down. High net worth reduces the necessary contribution rate. Less can be set aside if market conditions are favorable; more will need to be contributed if returns are unfavorable. Inflation increases savings requirements, but the actual contribution rate may not change if a person’s salary rises in accordance with inflation. The higher ending salary, however, will increase the dollar amount needed at retirement to achieve the same replacement rate. A shorter length of time until retirement raises the required savings rate because there are fewer years for savings to grow, though this can be partially offset by delaying the start of retirement. The TRI itself is also a variable—higher TRIs require greater savings.

Source: “Updated: What’s the Right Savings Rate?,” Daniel Gardner, CFA, Russell Research, July 2015.