How much money needs to be saved in order to ensure a comfortable lifestyle during retirement? Surveys show that many Americans do not have an answer to that question but fortunately there are a few common recommendations people can follow. For example, a financial advisor will often suggest that savers have enough money set aside so that around 80 percent of their annual income can be replaced, at least during the first few years of retirement. The idea is that since people typically do not spend 100 percent of their wages each year, an 80 percent replacement rate should be adequate to allow most of them to maintain the lifestyle they enjoyed prior to retirement.
Another popular rule of thumb used by financial advisers is that people should have at least 8 times their ending (pre-retirement) salary saved away before exiting the workforce. This accounts for other sources of retirement income like Social Security but some experts believe that setting even more money aside is required. Indeed, a study by Aon Hewitt analyzed the financial conditions of over 2 million working Americans and found that they would need to have at least 11 times their final pay saved away if they want to stop working at the traditional retirement age of 65 and be able to maintain their pre-retirement standard of living.
Other disagreements exist among professionals in both the financial services industry and academia on what the “correct” target replacement rate should be because there are so many variables to take into consideration, e.g. rising healthcare costs, the upward trend in life expectancy, and personal retirement lifestyle preferences. As a result, the best advice for most people to follow is that they should simply try to save as much money as possible for retirement and the sooner they can start to do so the better. Unfortunately, many Americans do not adhere to any such advice. Only a fifth of employees surveyed by Aon Hewitt, for instance, said that they are currently on track to “meet or exceed” their retirement income needs.
One thing that may be able to help is to teach retirement savers a few of the lessons of behavioral finance. Indeed, people have been found to be more likely to procrastinate when a deadline is a long way off, and LIMRA researchers as a result suggest that pre-retirees should be instructed to view long-term saving as a series of smaller goals rather than one big task. Specifically, if people aim to set aside 1x’s their annual salary by age 35, 2x’s by age 40, and so on (see above graphic) then they may have a higher likelihood of being on track to hit their long-term savings target, and in return better ensure a comfortable and financially secure retirement.
Sources: ThinkAdvisor, Aon Hewitt, Benefits Pro, LIMRAPost author: Charles Couch