Are You Saving Enough for Retirement?

Looking at historical precedent, most Americans aren't. How much money do you need to put away?

Even with Social Security, most Americans need to save well in excess of 5% of our income. But we don't.

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How much money are you saving for retirement? If you're a savvy saver, then you know one of the best ways to do so is to have some percentage of each paycheck automatically placed into a savings plan. You can often defer paying taxes on savings that way, and some companies even match some portion of your savings in a 401(k) or other retirement plan. But how much of each paycheck should you be saving to retire at a reasonable age? Unfortunately, the number is different for everyone, but there's little doubt that most Americans aren't saving enough.

It always helps to think about saving with some historical context. Here's a chart showing the portion of personal income that Americans have saved since 1959, according to the Bureau of Economic Analysis:

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You can see that saving grew to be at or above 8% until the 1980s. During that decade it declined to around 6%, before moving to 4% in the 1990s. In the last decade, it went even lower, but has rebounded recently, settling at around 5%.

Through a little financial analysis, it's pretty clear that this 5% savings rate is woefully inadequate for most Americans, no matter what career stage they are in, if they hope that savings will produce an adequate income after the age of 65. Social Security may help, but necessary deficit cutting over the next several years could dampen its impact. Even at Social Security's current rate, however, most Americans need to save well in excess of 5%.

The Money Report

How much you need to save is determined by a number of variables. First, it depends on your age, when you intend to retire, and how many years you estimate you will live. You also need to decide how much money you want your savings to provide each year during retirement. Then, you must make assumptions about the rate of inflation and the rate of return on your savings.

So how much you should save can't be summed up in a quick article, because it's different for everyone. But let's consider an example to get an idea of a minimum that might be required. So we'll start with a 22-year-old college grade named Fred. He just got a job making $50,000 -- the average starting salary this year for college grads, according to the National Association of Colleges and Employers. Fred wants to retire when he's 65 years old. He also wants his retirement income derived from savings to match his starting income out of college, after adjusting for inflation. Now let's make some assumptions about the future:

1) Inflation will be 3.5% per year (reasonable, as it's been 3.7% since 1950).

2) His compensation will increase by 3.5% per year, on average (reasonable, since average wage growth has virtually matched inflation since 1979).

3) He will invest in the S&P500, which will average a nominal 7.5% annual return on his savings (a favorable assumption, as the index has averaged 7.4% annually since 1959, but U.S. growth will likely be a little slower going forward).

4) He will live to be 85 years old.

Next, we have to estimate how much Fred will be provided by Social Security. Luckily, there's an easy way to estimate this through a government website. In 2054 dollars (when he will retire), Social Security would provide an initial annual benefit of $89,508. In 2011 dollars, that would be $18,372 -- about 37% of $50,000 income wants. He must get the rest from his personal savings.

So what constant portion of his paycheck must he save for those 43 years, from when he first joins the workforce, to achieve his goal? He must save somewhere between 8% and 9% of his gross income.

That doesn't sound too drastic, but it's still far more than the average saving rate in the U.S. And it's probably something of a minimum. It uses some very generous assumptions. For example, if you take Social Security out of the equation, his savings rate would have to be 15%. So if its impact is lessened, then his saving would have to be somewhere between 9% and 15%.

This analysis also assumes his saving's investment will grow at a brisk 7.5% per year. If it only averages 6% growth, then his savings rate would need to approach 14%. If his rate of return only matches inflation at 3.5%, then his savings rate would have to be a whopping 30%.

The example above also assumes that he begins saving the moment he enters the workforce and that he never deviates from his savings rate. Many young people do not save much immediately, particularly if they have big college loans to pay back. And if a person experiences a period of unemployment as some point in his or her life, that not only prevents saving for a period of time, but the hardship might also cause the person to dip into savings to cover daily expenses until new work is found.

Although determining how much you must save takes some mathematical know-how, these days there are a number of websites that can help you create an estimate. One can be found at It has a pretty good ballpark estimator that matches up closely with the model that I created independently. It's also quite versatile, so most people will find it useful.

In a consumerist society, it always seems like there's a cool new gadget to buy or nicer car you want. But resistance has its benefits. Saving now can allow for more leisure later. And by having money automatically deducted from your paycheck, you might not miss it as much as you would think.

Image: SCA Svenska Cellulosa Aktiebolaget/Flickr