4 rules when saving for retirement
Follow these guidelines to stay on track.
Perhaps the most daunting financial challenge most people face is estimating how much money they will need in retirement. It’s a difficult task because there are so many moving parts and unknowable variables – from estimating how long you will live to forecasting how much your investments will yield.
Fidelity Investments recently explained four key savings rules of thumb that can help provide a feel for whether you’re on track.
In a lot of areas, Americans’ financial literacy is much higher than it is in other nations, said Mark Sullivan, head of Fidelity’s international benefits consulting group in London. Part of the rationale behind the report was to “take the best practices of the U.S. and deploy them internationally,” he said.
1. How much to save each year
Fidelity’s first rule of thumb is to try saving at least 15 percent of your gross income, preferably over your entire career. If you earn around $50,000 a year, not far from the U.S. median income, you would want to sock away $7,500 annually.
This amount can include employer matching funds if you participate in a 401(k)-style retirement plan at work, Sullivan said in an interview.
2. Savings as a multiple of salary
Another way to approach retirement planning is by calculating the total amount of money you might need to save.
Rather than pick a number out of the blue, Fidelity recommends that Americans strive to accumulate at least 10 times their final yearly salary. Someone who earned $50,000 in that final year of full-time work would want at least $500,000 saved by the time they retired, presumably around age 67. Younger retirees would need higher amounts.
Housing equity counts toward this 10-times savings figure, making it more attainable for people who own homes.
Fidelity’s study assumes that most people will spend a bit less in retirement than during their working years, though they might splurge early in retirement by purchasing a new vehicle or taking costly vacations, Sullivan said.
Conversely, they might spend a lot on health care, but that typically comes later in retirement.
3. How much can you safely withdraw?
This indicator puts retirement planning into the context of both spending and investment performance. Fidelity suggests that Americans withdraw no more than 4.5 percent of their savings each year to make ends meet in retirement – if they want to keep their nest eggs more or less intact.
So if you have $500,000 saved up, you could safely withdraw about $22,500 yearly, supplemented by what you get from Social Security.
One assumption here is that retirees hold most assets in bonds and other fairly stable fixed-income instruments – and not too much in stocks or stock mutual funds. Equities are great for generating long-term growth, which even young retirees need, but stocks are much more volatile.
If you withdrew even 4.5 percent from a stock-based portfolio during a sharp down year, it could blow a sizable hole in your portfolio that could take years to mend.
4. What about income replacement?
The fourth guideline from Fidelity estimates how much of your spending in retirement should be met with personal savings, as opposed to Social Security or similar government plans in other nations. Americans should try to amass enough savings (including employer pension income, if any) to cover at least 45 percent of their retirement spending, with Social Security covering the other 55 percent. This assumes people will want a retirement lifestyle similar to what they had while working.