• Harry N. Stout

241- How Much Do You Need to Retire? Rules of Thumb for Retirement Savings


One of the most frequently asked personal finance questions is, How much do I need to retire? People usually want a quick answer and don’t want to take a lot of time to fully understand or explain their personal situation. As we have discussed in several posts, to properly plan for your non-working years you should develop a detailed plan with a qualified financial professional that properly addresses all your needs and desires.


For people who want a quick answer as to what they need to save, there are a number of industry “Rules of Thumb” that are used. Remember, a Rule of Thumb is an approximate method for doing something, based on practical experience rather than theory. It is not a detailed calculation based on an in-depth look at your personal situation. It is a quick and imprecise estimation.


Rules of Thumb date back to the seventeenth century and has been associated with various trades groups where quantities were measured by comparison to the width or length of a thumb. Retirement savings Rules of Thumb can be useful in that they may help you to become more aware of how your retirement savings compare and how comfortable you should be with the direction you are headed.


Rule of Thumb 1 - Saving A Multiple of Your Income

This Rule of Thumb states that for a current age you should have saved a certain amount. Fidelity Investments had a great recent article on this subject that I recommend you should read.


The article spells out this Rule of Thumb very clearly. The key takeaways from the article were:

  • Fidelity's rule of thumb: Aim to save at least 1x your salary by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67.

  • Factors that will impact your personal savings goal include the age you plan to retire and the lifestyle you hope to have in retirement.

  • If you're behind, don't fret. There are ways to catch up. The key is to plan and act.

Source: Fidelity Investments


If you want to understand and potentially follow Fidelity’s Rule of Thumb, please read the entire article, including the assumptions they have used in their analysis.


Rule 2 – The 4% Rule

The 4% Rule is a Rule of Thumb is used to determine how much a retiree should withdraw from a retirement account each year. The 4% is then used to determine if enough has been accumulated to create an amount that covers all living expenses. This rule seeks to provide a steady income stream to the retiree to cover their living expenses while also maintaining an account balance that keeps income flowing through retirement. Experts are divided on whether the 4% withdrawal rate is safe, as the withdrawals are not guaranteed and will consist primarily of interest and dividends that could decrease over time due to lower interest rate levels and corporate earnings performance.


Key takeaways about this rule include:

  • The 4% Rule is a rule of thumb used to determine how much a retiree should withdraw from a retirement account each year.

  • The 4% Rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976 when interest rates were at much higher levels.

  • The 4% Rule seeks to provide a steady income stream to the retiree while also maintaining an account balance that keeps income flowing through retirement.

  • The 4% Rule has been used by financial planners and retirees to set a portfolio's withdrawal rate.

  • Life expectancy plays an important role in determining if this rate. If you can expect a lengthy retirement based on your above average health you may need to use a much lower rate of withdrawal.

Overall, in today’s financial media there is significant debate about whether 4% is too high a rate of withdrawal and whether a rate closer to 2% should be used. The key reason for the debate is the low interest rate environment we have today and how it impacts available investment yields.


Rule 3 – Saving 15% of Your Income

The most common Rule of Thumb found in the financial media is that families should save 10% to 15% of their gross (before taxes) pay over a projected 30 to 40 year working life. Many organizations promote this percentage. I have written that you may need to save more than this amount given your personal situation and the fact that due to illness, unemployment or other life events you may have some years when you cannot save very much.


Whether this percentage will allow you to accumulate the assets you need to retire will depend on the number of years you have to retirement, your level of income, your projected living expenses and whether you have a negative life event such as an illness or disability.


Rule 4 – The 25 Times Rule

This rule simply states that you should have 25 times your annual living expenses saved at the time you retire. The assumption here is that your retirement will likely not be more than 25 years and that you have some margin of safety in that this amount will have earnings that can be used to pay living expenses.


Summary

Rules of Thumb are just that — quick estimations measuring a situation. When it comes to your personal financial situation, they can yield some benefit to demonstrate the direction in which you are headed. They do not take into consideration your individual situation, wants and needs. As I written, it is best to have a financial plan in place that addresses your personal requirements. When it comes to retirement savings you do not get a second chance to get the number right.

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