To answer the question definitively, you have to know how long you’ll be working (and saving), how long you’ll live in retirement, and what the investment returns will be both during the accumulation period and also throughout your retirement years.
Wade Pfau, a researcher who is currently director of macroeconomic policy program at the National Graduate Institute for Policy Studies (based in Tokyo, Japan), conducted an interesting study that tries to help us sort out the possibilities. To start with, Pfau assumed that a hypothetical person (let’s call him Fred) would work for 30 years at a salary that goes up with the inflation rate, and then retire for 30 years. Each year, Fred would save the same percentage of his salary. Pfau also assumed that Fred would need 50% of his final year’s income–on top of Social Security and any pension resources–to pay for retirement living expenses out of his portfolio.
In the first year of retirement, Fred would draw out 4% of his portfolio. After that, to maintain buying power, he would take out ever-higher amounts based on the inflation rate in each of the subsequent 29 years. For the entire 60 years, Fred’s money is invested in an unsophisticated (but easy to calculate) portfolio consisting of 60% stocks and 40% bonds with a six-month maturity.
Then Pfau considered what would have happened for every rolling 60-year period from 1871 to the present and, looking backwards, calculated the percentage that Fred would have had to save to reach his goal.
The results? Pfau found that if Fred struggled to save and accumulate during a relentless bear market, he would often have a better-than-average chance of catching a bull market in retirement, and vice versa. The highest required yearly savings rate when he took into account the full 60 year period came to 16.62% for the unlucky person who entered the workforce in 1918. The more normal scenarios require Fred to save anywhere from 12% to 15% a year.
Of course, people who delay setting aside retirement money to later in life–if, for example, they start saving in their 40s and expect to retire at age 60–will see this savings percentage go up accordingly. Toward the end of his research report, Pfau discovered that if Fred only saved for 20 years, and expected a 30-year retirement, he should be prepared to set aside at least 30% of his annual income during this truncated savings period. On the other hand, if Fred set aside money for 40 years, his minimum savings rate drops dramatically, to between 6% and 14% percent.
It is important to recognize that this is a model, not a prediction of what will happen in the future. We don’t know what future returns will be, either while people are putting money aside or during their golden years. Beyond that, we know that some people will spend more in their retirement years than their pre-retirement income, simply because they have more free time to enjoy.
Each person, and each sequence of years, is different, and requires more precise individual planning than any researcher can do in a broad study. But this study offers us a pretty good look at how the different variables can play out in the long lifespans we are enjoying today, a window into how easy, or hard, it can be to save for the third stage of our lives.
Fortunately, at KFG we use use the Money Guide Pro modeling software to take the guess work out of how much a person needs to save to hit their retirement spending goals. Of course, the variables are limitless but with constant monitoring and modifications, we can be relatively certain our clients are on the path to achieve their goals.