Why It’s So Hard to Know How Much Retirement Savings Is Enough

Most online tools recommend having 10 times one’s salary on hand before retiring. Is that too much or just right?

Kim Kyung Hoon / Reuters

Online financial-planning tools have a habit of spitting out terrifying numbers when people use them to figure out how much to save for retirement. Most tools, from the AARP’s to the Social Security Administration’s, yield similar answers when one enters spending estimates, expected salary increases, and assets: They tend to advise their users (most of whom are workers in their 40s or 50s) to have 10 times the amount of their salary in savings before they retire. It’s a cutoff that some economists claim is too high, but it’s actually quite realistic—and presents a good argument for saving aggressively.

Ten times most people’s salaries is usually a lot higher than what they have saved up. First, more than half of workers don’t have more than a few thousand dollars saved up in retirement accounts. And by the time the average professional is between the ages of 50 and 64, his or her household has accumulated about $181,000 in 401(k) and IRA accounts. That’s only 10 times their salaries if they’re earning below the poverty line.

But there are several economists who reject this recommendation. A study by two respected economists from the University of Wisconsin-Madison suggests that these 10-times-your-salary targets are far too high, and that few households are under-saving. According to these economists, many financial-planning tools overstate required savings because they fail to take account of the cost of raising kids. The thinking goes that by the time people retire, they don’t need as much money on hand, because they won’t be supporting children anymore. Similarly, the economist Larry Kotlikoff has argued that people tend to overestimate how much money they’ll spend in retirement, and Andrew Biggs and Sylvester Schieber have argued that people have more assets than are measured. All of these economists are suggesting that there isn't a retirement-savings crisis.

The arguments from those Wisconsin economists, John Karl Scholtz and Ananth Seshardi, are often used to justify policies that would limit the expansion of Social Security and prevent the formation of a universal pension system. Because these policies have far-reaching implications, it’s worth inspecting Scholtz and Seshardi’s argument, which essentially boils down to this: Spending a lot of money to raise children is good preparation for retirement.

Their calculations are complicated, but the narrative is straightforward. A household starts off young, poor, and in love. Children are the natural consequence. The household’s income increases, but the children’s needs eat up all the extra income and the family remains poor.  Eventually the children leave home. But their parents are rational and far-sighted, have read their Milton Friedman, live according to a life-cycle theory of consumption, and balance their spending in the present with the knowledge that they will need to buy other things in the future. This rational view of their financial life cycle means that they will save aggressively in the period after their kids leave home and before they retire—simply because their own consumption remains at the same level and their kids are no longer around.

But in this model, there is no downward mobility of salary, no sickness or layoffs, no extra vacations or entertainment. The parents take what they spent on the kids, the theory goes, and put it into their retirement accounts. They don’t need to accumulate wealth equal to 10 times their income—because their goal is to simply maintain their low standard of living.

But that narrative doesn’t align with reality. A new study of a large number of American households takes on those assumptions and examines the actual behavior of parents when their children leave home. Using tax records, a team made up of economists from Boston College and the Social Security Administration found that the balances in parents’ retirement accounts—which is where most people put their savings away—only increased by one percent, on average, when their children left home.

Their survey didn’t determine why people didn’t save aggressively—perhaps their adult children were still laying claim to some slice of their parents’ income, or perhaps the costs of maintaining a household remain high when kids aren’t present. But in any case, it suggests that the benefits of saving up multiples more than one’s current salary for retirement are not at all exaggerated.