In America you are mostly on your own for retirement. You would be totally on your own if it weren’t for Medicare, Medicaid and Social Security. But Social Security replaces only about 40-50% of income and you will need about 70-80% in retirement.
How much do you need to save to be OK in retirement? You need to calculate a target "number" for retirement – how much you'll need to have saved – and then translate that target number into a weekly amount to be deducted from your paycheck.
You have to make a lot of assumptions in determining how much to deduct from every paycheck in order to retire well. If you are a median worker, you need about $350,000 in addition to Social Security. If you are a typical college-educated professional, you will need over a million or two.
Let’s assume that you replace 80% of your preretirement income in retirement; you earn a little above average ($60,000 in 2019); you work and save consistently for 42 years – no taking breaks, no getting laid off or fired, no divorces, no getting sick – you earn 5% on your investments after fees; you live until 95; and you collect Social Security. Whew, lots of assumptions.
You need to save 5% of every paycheck if you start at age 25. You need to save 10% if you start at age 35, 22% if you start at age 45, and 52% of every paycheck(!) if you start at age 55.
To tailor your answers and fiddle with the assumptions, go to calculators. The NerdWallet calculator is OK. Make sure you calculate your Social Security benefit – the NerdWallet calculator will send you to an excellent AARP calculator – and avoid the NerdWallet sales pitches. Just use the calculators. My colleague Anthony Webb provides a great consumer guide to retirement calculators.
When you decide the amount you want to save you have to decide how. First stop is your firm’s 401(k). I know half of workers don’t have a 401(k) plan at work, or any kind of plan at all. Those without a workplace plan need an IRA – choose Vanguard with the lowest fee index funds please. But if you are older and catching up you won’t be able to save enough in your IRA, contributions are capped at $6000 - $7000 per year. You will have to amass wealth outside retirement accounts in the form of a paid off house and no debt, and mutual funds (index please).
The Fantasy Play in American Retirement Planning
The tips and guideposts and links to retirement calculators might have seemed to be grounded in a meaningful reality. I set out to answer the fairly ordinary sounding question, “how much do I deduct from my paycheck to be OK in retirement?” However, most retirement saving advice is not connected in any meaningful way to the ordinary lived experiences of the vast majority of American workers. Basically, almost no one starts saving 5% of their paycheck for retirement when they are 25 and continues to do so for 504 months (12 months*42 years) straight without pause.
And the number of people who plan to save 52% of their paycheck when they are 55 is precisely no one. The only chance people have of having a decent pension supplementing Social Security is starting a career job in a union, a large company, or a government job in which you were likely to have a traditional defined benefit pension or a generous 401(k)-type plan. Your only other hope for a secure retirement is a rich spouse or parent and by definition, there are not many of those to go around. I wrote about savings tips hoping a few people could get lucky and follow the advice, but I acknowledge I am offering tips amid the rubble of a broken retirement system – handing out umbrellas during Hurricane Maria.
Very few people have the savings needed for retirement. Most workers approaching retirement do not have enough saved to maintain their living standards in retirement, regardless of income. The typical older worker in the bottom 50% of the income distribution (earning less than $40,000/year) has nothing saved for retirement. The median savings of workers in the middle 40% (earning between $40,000 and $115,000/year) are only $60,000. Among workers in the top 10% of the income distribution (above $115,000/year), the median amount saved is $200,000.
It is easy to know how much you need in retirement. Figure out when you are going to die, when your employer will throw you out, predict all the recessions and invest accordingly, avoid the predator financial advisers and brokers, know the future of your industry, the success of your love life and the life course of your children. I am tongue in cheek of course in listing this string of dos and don’ts to illustrate a major point. American workers are asked to do the near impossible. Other countries have Social Security systems combined with occupational plans that use rules of thumbs to get most workers, those who have worked 30-40 years, to about 70-80 percent of their pre-retirement income in retirement. America needs a pension plan for all plan. The indefatigable Chris Carosa interviewed me about my plan for a universal pension plan a few days ago.
*A word about replacement rates. Andrew Biggs has a good paper on retirement targets and Social Security replacement rates. He finds the college teachers retirement plan, TIAA-CREF recommends a desired replacement ratio of 60 percent to 90 percent of an persons salary during their last year of work. Aon Consulting and Georgia State University recommend an average replacement rate of about 75 percent of final earnings, with low earners requiring replacement rates of close to 90 percent.