According to fourth-quarter 2012 data for defined contribution plans administered by MassMutual (as reported by media site BenefitsPro.com), the average deferral rate was 5.38 percent for women participants and 5.81 percent for men. This was reportedly the highest savings rate in four years.
That’s the good news. But is a 5 percent or 6 percent savings rate sufficient to accumulate enough money to carry us through 30 years of postretirement bliss?
While the answer uniquely depends on the specific future goals, expenses and saving/spending patterns of each individual or family, it is possible to calculate an “average” savings rate that could provide some indication of how much each of us should be saving while we’re working – if we plan to do anything in retirement beyond fishing and eating Spam.
I designed a simple spreadsheet to do just that, and the results are not encouraging. First, the assumptions:
• You graduate college at age 22 and work for 42 years.
• Your salary keeps up with inflation.
• You get a 5 percent bonus (or change to a 5 percent more lucrative job) every five years.
• The growth rate of your savings is 7 percent annually (both before and after retirement).
• You retire at age 65 and live until age 95.
• Your postretirement expenses are similar to your preretirement expenses.
• Social Security covers 20 percent of your retirement expenses.
Assuming the above, you need to save approximately 18 percent of your salary during each of your working years to maintain your standard of living throughout your postretirement years.
Of course, these assumptions will not apply to everyone’s situation. For one thing, our savings are not consistent from year to year. We buy houses, we have children and we discover new hobbies and interests as we journey through life. We may even transfer to significantly higher-paying jobs and possibly save more than 18 percent in our later working years. Or alternatively, we become accustomed to a higher standard of living, requiring an even larger nest egg at retirement.
Then there’s Social Security, slated for bankruptcy in the near future unless our political leaders are able to compromise on a fix. What do you think the most likely outcome of that debate will be?
Investment growth rates are another factor that will have a significant effect on our total savings. How realistic is 7 percent on average each year? Given current world economic conditions, coupled with the potential for a long period of rising interest rates, many advisers (including me) consider 7 percent a fairly aggressive long-term target growth rate. I ran the numbers with a 6 percent growth rate and that resulted in a requisite 24 percent annual savings rate.
The point here is that saving 6 percent a year for retirement is nowhere near enough. Even if you max out your 401(k), you may not be accumulating a sufficient level of savings to last throughout a long period of retirement.
If you haven’t already done so, plan what you would like to do in retirement and how much it will cost, then make sure to allocate a sufficient amount of your family’s budget to cover your anticipated future needs.
Los Altos resident Artie Green is a Certified Financial Planner with Cognizant Wealth Advisors. For more information, call 209-4062.