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How much should I save to prepare for a comfortable retirement? Most people ask themselves this question at some point in their working life (hopefully, relatively early). With the continued shift toward defined contribution plans, future retirees are being asked to take on more responsibility for their retirement outcomes than in the past. So the question is of vital importance. But is there a good answer?

Determining how much to save for retirement is challenging, given the high uncertainty about income, portfolio returns, and spending needs many years into the future. It is important to note that simple rules of thumb do not work for many people. Given the high heterogeneity of earning potential and spending needs, what works well on average does not work well for everyone. A one-size-fits-all savings rate during one’s working life may be too high for some and too low for others.

### How Much Income To Replace

The first step to determine an appropriate saving rate is to estimate how much retirement spending will be financed with retirement savings. While this estimate is specific to each individual, general guidelines about reasonable replacement rates are available. Replacement rates are normally less than 100% of preretirement income because spending tends to decline with age, households tend to pay less tax in retirement, and saving for retirement is no longer required. These three factors become increasingly important as income rises.

**Exhibit 1** shows replacement rates from Lee (2012)^{[1]}. As a percentage of gross, preretirement income, replacement rates range from 82% for the bottom 25% of the income distribution to 58% for the top 25%. Low income households can rely on Social Security to replace most of their preretirement income, while high earners need to rely more on personal savings. For households with no pension income, replacement rates out of personal savings are estimated to be between 23% for the lowest income quartile and 37% for the top quartile. Based on these estimates, we use a conservative 40% replacement rate for the next analysis below.

**Exhibit 1: REPLACEMENT RATES NEEDED BY INCOME**

Replacement rates as a percentage of gross preretirement income

### Safety Is Costly

Given a replacement rate, required saving rates depend on individual income paths, portfolio returns, and assumed withdrawal rates or annuity pricing at retirement. **Exhibit 2** shows the saving rates needed for 95%, 90%, and 50% success probabilities for an individual who starts consistently saving at age 25 and retires at age 65. We find that to replace 40% of preretirement income with 95% probability, households need to save 16.8% of their salary from age 25 to 65. For a 90% success rate, the savings rate needed is 13.2%, and it is substantially lower for a 50% success rate, which can be achieved with less than a third of the savings needed for 95% probability. The change in saving rates required to increase the probability of success is a measure of the cost to safeguard against shortfalls using the assumed allocation strategy. **Exhibit 2** shows that safety is costly.

**Exhibit 2: SAVINGS RATES FOR AT LEAST 40% AND 20% INCOME REPLACEMENT**

Results based on Monte Carlo simulations of income profiles, stock returns, and bond returns for 100,000 households. Income profiles calibrated using PSID data and census data. Stock and bond returns bootstrapped using historical returns.

The portfolios are rebalanced yearly in the simulation. Global equity returns are from the Dimson-Marsh-Staunton Global Returns database. Five-year Treasury notes are from Ibbotson. The data cover the period 1926 to 2011. Real annual equity returns average 7.7%, with a standard deviation of 19%. Real returns on five-year Treasury notes average 2.5%, with a standard deviation of 6.8%. As is typical in this type of simulation, we interpret the frequency with which a replacement rate is achieved across paths as an estimate of the probability of success, or success rate. These are total savings rates into personal accounts, so they would include any employer contributions.

### Starting Early Matters

What about individuals who start saving later? **Exhibit 3** shows saving rates for individuals who begin saving at ages 30 or 35, seeking a 40% replacement. An individual who targets a 90% success rate needs to save 15.4% if she starts at age 30 or 19.2% if she starts at age 35—much higher than the 13.2% saving rate required when starting at age 25. Starting early and saving consistently should be a priority when planning for retirement.

**Exhibit 3: EFFECT OF STARTING AGE ON SAVINGS RATES**

Seeking a 40% replacement rate

### Save More With Increasing Income

A saving rule in which the saving rate increases with income is consistent with standard economic theory. The results are shown in **Exhibit 4**. A 25-year-old making $48,000 can start by saving 6.6% for a 90% probability of success, and gradually increase savings through time (to 8.8% as she crosses the $50,000 threshold, 11% as he crosses $60,000, etc.). If she has a college degree, her income is expected to peak at $120,000 by age 45. At that time, she should be saving 17.6%.

**Exhibit 4: SAVING MORE AS INCOME GROWS**

Savings rates needed to reach a 40% replacement rate by income range and success probability

### Checking Your Progress

Over time, individuals may deviate from their savings plans because of unexpected personal events, higher or lower accumulated assets than expected, or changes in retirement goals. In any event, it is good practice to evaluate one’s progress and make appropriate changes if needed.

A useful measure of intermediate performance is accumulated assets divided by current income, the asset- income multiple. The greater this multiple is, the greater the chance to achieve a given target replacement rate. Given an asset-income multiple, we can calculate the additional saving (or dissaving) needed to meet a replacement rate going forward. If the asset-income multiple is too low, additional savings are needed (relative to a previously followed rule). If the asset-income multiple is very high, the savings rate could be reduced to target a given success probability.

**Exhibit 5** shows target asset-income multiples at intermediate ages 35, 45, and 55, for a 90% success rate. It also shows asset-income levels for which a 1 percentage point adjustment (up or down) in the saving rate is required to be on track. A 35-year-old targeting a 40% replacement with an asset-income multiple of 1.00 is on track and can continue with the rule of Exhibit 5 but would need to increase the saving rate by 1 percentage point with assets equal to 0.75 times his current income. He could decrease the saving rate by 1 percentage point with 1.25 times his current income.

**Exhibit 5: TARGET ASSET/INCOME MULTIPLES**

Assuming targets of a 40% replacement rate and a 90% success probability

### Summary

First, start early, even at low saving rates. Missed years have a non-trivial impact on future saving rates, and the early buildup of assets can offer flexibility later in life. Similarly, save consistently over time. Increase savings with income, as in Exhibit 5, particularly if you are uncertain about future income growth. This will bring down savings rates for low earners without compromising chances for individuals who will experience high income growth. Third, keep track of performance by monitoring accumulated savings and savings rates as income changes, and make changes as needed—along the lines of Exhibit 5. Consistent with these guidelines, and in the spirit of minimizing the cost of saving, take maximum advantage of employer contributions.

### Summary Video: How Much Do You Need To Save For Retirement

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The projections or other information generated by Monte Carlo analysis tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use and over time. These hypothetical returns are used for discussion purposes only and are not intended to represent, and should not be construed to represent, predictions of future rates of return. Actual returns may vary significantly.

1. Marlena Lee, “The Retirement Income Equation,” DC Dimensions (Summer 2012). Refer to this paper for a more complete discussion about replacement rates.