Retirement Savings “Enough” Metrics
September 10, 2024
By Barbara O'Neill, CFP®, AFC®
A frequently asked retirement planning question is “how much is enough?” In other words, how much money do people need to save in tax-deferred accounts such as 403(b) plans and other investments such as tax-free Roth IRAs and taxable brokerage accounts? The correct answer to the “enough question” is “it depends.” Key variables include current age, planned retirement age, health status, future spending goals, the rate of return earned on investments, and anticipated sources of retirement income (e.g., pension and Social Security).
There is no magic retirement savings number that fits everyone. There are, however, metrics to make educated estimates about what you need to save and whether you are on track for a comfortable lifestyle in later life. These metrics fall into three general categories: a specific dollar amount (e.g., $1 million), a replacement percentage of pre-retirement income (e.g., 80%), and multiples of pre-retirement income at various ages.
This post describes ten retirement savings “enough” metrics including net worth, The Millionaire Next Door (TMND) wealth formula, two age multiple guidelines, the 25-4 rule, pre-retirement income replacement ratios, Monte Carlo simulations, pension and benefit benchmarks, pro forma budgets, and the 15% savings rule. It concludes with a summary of research about the amount of money Americans think they need to save for a comfortable retirement, three “need to know” facts, and six take-away action steps.
Ten “Enough” Metrics
Net Worth — Net worth is calculated by subtracting debts from assets. For example, $500,000 of assets minus $150,000 of debt equals a net worth of $350,000. Three categories of assets are cash assets (e.g., bank accounts, money market funds, and certificates of deposit), investment assets (e.g., 403(b) accounts, IRAs, and mutual funds), and property assets (e.g., house, car, and home furnishings). Two categories of debt are current debts (i.e., debts expected to be repaid within a year) and long-term debts (e.g., car loans, student loans, and mortgages).
Over time, net worth can grow steadily through increased savings and/or reduced debt. Some people set specific goals such as a $1 million net worth before retirement. The more wealth people accumulate, the more income they can withdraw annually in later life. For example, if 4% of savings is withdrawn during the first year of retirement, someone could withdraw $12,000 annually with $300,000 of savings and $20,000, $40,000 and $60,000, respectively, with $500,000, $1 million and $1.5 million of savings.
TMND Wealth Formula
A net worth figure is most useful when viewed in the context of someone’s age and income. In the book The Millionaire Next Door by Stanley and Danko, the authors describe a formula to determine the adequacy of someone’s net worth at any point in life. The formula works as follows: multiply your age by your realized pretax annual income from all sources, excluding inheritances, and divide by 10.
Example: a teacher, age 50, with a salary + other income of $70,000 should have a net worth of $350,000, calculated as follows: 50 x $70,000 = $3,500,000 ÷ 10 = $350,000. The number derived from the formula is what the minimum net worth should be for a particular age and income combination. The more people exceed their formula-based figure, the better. For couples, add the spouse’s “numbers” together for a household total.
Fidelity Age-Income Multiples
403bwise Green+ vendor, Fidelity, ran analyses that assumed workers save 15% of their income annually beginning at age 25, invest more than 50% of their savings in stocks, and retire at age 67. They estimated that saving 10 times pre-retirement income by age 67 should help workers maintain their current lifestyle in retirement. Fidelity then created age-based milestones from age 30 to 67 to help workers measure their progress. These age-based income multiple milestones are shown below.
T. Rowe Price Age-Income Multiples
Similar to Fidelity, 403bwise Green- vendor T. Rowe Price created age-based income multiple milestones based on an array of assumptions including household income growth (5% until age 45 and 3% thereafter), a 7% investment return before taxes, retirement at age 65, and individual or household income between $75,000 and $250,000. T. Rowe Price’s age-based income multiple milestones for various ages are shown below.
The 25-4 Rule
The 4% Rule is a frequently cited guideline for retirement savings withdrawals. It suggests withdrawing 4% of savings initially and adjusting withdrawals annually for inflation for a high probability of not outliving your money within 30 years. Extending the 4% Rule, someone should save $300,000 for every $1,000 monthly withdrawal needed in retirement ($300,000 x .04 = $12,000/year or $1,000/month). The 4% Rule assumes at least 50% of a portfolio is invested in stock. Note: For tax-deferred accounts, such as 403(b)s, required minimum distribution (RMD) rules take precedence over other withdrawal methods starting at ages 73 or 75.
The 25-4 Rule (a.k.a., Rule of 25) is an extension of the 4% Rule used by many Financial Independence, Retire Early (FIRE) proponents. To calculate a savings target, multiply your desired annual income goal by 25 and withdraw 4% of savings annually. For example, if you need to generate $40,000 annually to supplement guaranteed income sources (e.g., pension and Social Security), you need to save $1 million ($40,000 x 25). The 25 year time frame aligns, for example, with life expectancy of age 90 (92) and retirement at age 65 (67).
Pre-Retirement Income Replacement Ratios
Another popular guideline, the so-called 80% Rule, suggests that retirees can maintain their standard of living on 80% of their final year of pre-retirement gross income. Some sources even suggest 70%. In other words, a couple with a $100,000 household income could live on $70,000 to $80,000 due to reductions in retirement savings, payroll deductions for Social Security and Medicare, income taxes, and work-related expenses such as commuting. Note: some financial advisors disagree and suggest 100% to 130% of final income, especially for the early “go-go” retirement years, because “every day is a weekend” and spending often increases.
Whatever replacement ratio is selected, convert it to an income amount to insert into financial calculators to determine how much you need to save. This website provides a detailed review of ten retirement calculators including a very user-friendly calculator from Vanguard. It is best to try at least three retirement planning calculators because their assumptions and data inputs vary. This website provides information about how much can be contributed to different retirement savings plans.
Monte Carlo Simulations
Monte Carlo probability modeling is a simulation of possible investment outcomes, based on historical data, that is used to predict the likelihood of sustaining a certain withdrawal rate for, say, 30 years. In other words, the probability of success (i.e., not running out of money during your lifetime). Obviously, a 95% probability of success is much better than, say, 40% or 50%. A high probability of success indicates that retirement savings is probably adequate. A low probability of success indicates that additional savings is needed.
Monte Carlo calculations can be done by financial advisors for their clients or by investors themselves. With the search term “Monte Carlo Calculator,” several online calculators will appear.
Pension and Benefit Benchmarks
Another metric for “enough” is meeting longevity benchmarks set by an employer or state for receipt of a pension and/or retiree health benefits. Compared to most workers, public employees (e.g., teachers) are very lucky in this regard. However, there are specific rules to follow regarding when benefits kick in or max out.
Example: Me. My federal CSRS pension maxes out after 41 years, 11 months and I left Rutgers Cooperative Extension after 41 years, 4 months (I did not want to spend another cold winter in New Jersey!). In addition, after 25 years of service credit as a New Jersey employee, I qualified for retiree health benefits.
Pro Forma Budgets
Pro forma budgets are a “best estimate” of future income and expenses. They are used by businesses to make profitability forecasts but can also be used in personal finance. The closer one is to retirement (e.g., within five years), the more accurate a pro forma budget is likely to be. The objective is to list household expenses you expect to end or decrease in retirement (e.g., retirement savings plan contributions, work expenses, and housing costs if a mortgage is repaid). Then make a similar list of expenses that you expect to increase. Examples include travel and entertainment and health care (e.g., Medicare premiums).
Any standard budgeting worksheet, spreadsheet, or app can be used to create a pro forma budget. Once it is complete, projected expense data can be compared with current (pre-retirement) spending and the replacement ratios described above. Ideally, the results should be similar. Is anticipated income in the pro forma budget close to replacement ratios of 70% or 80% of pre-retirement income or 100% or higher?
Like the numbers derived from income replacement ratios, anticipated living costs from a pro forma budget can be inputted into retirement planning calculators to determine how much you need to save.
The 15% Savings Rule
This is not an “enough” metric per se but the means to an end (enough). T. Rowe Price and others note that saving at least 15% of gross income annually throughout a four-decade career should result in about $1 million of savings at retirement. For example, a 22-year old teacher with a $40,000 starting salary would save $6,000 in year one. Thereafter, the savings amount would adjust for changes in pay scale and contracts.
Research Results
Once upon a time, having $1 million saved by retirement was considered the holy grail to reach and a 2006 book called The Number highlighted it as a savings target. Over time, however, the amount of money Americans say they need to have a comfortable retirement has been rising. Earlier this year, Northwestern Mutual’s 2024 Planning and Progress Study found that Americans say they need $1.46 million saved to retire comfortably. This was a 15% increase from $1.27 million in 2023 and a 53% increase from a $951,000 goal in 2020. Recent high inflation in the cost of goods and services is undoubtedly a contributing factor.
Sadly, the gap between the amount people say they need and their savings progress has increased as well. According to the Federal Reserve 2022 Survey of Consumer Finances, Americans’ median and average retirement savings were $87,000 and $333,940. The age range 65-74 has the highest accumulated wealth.
Three (More) Things
- Having a precise retirement savings target can inform how much to save in a 403(b) and other investment accounts. It is best to compare several “enough” metrics for a comprehensive analysis of your finances.
- Public school employees with pensions and/or health benefits often retire earlier than many workers. The earlier you retire, the longer you have to support yourself in retirement and face unexpected expenses.
- There is no single measure of “enough” that fits everyone. Rather, your “number” will depend on your expected lifestyle (e.g., world traveler vs. homebody). Hence the need for a customized pro forma budget.
Six Smart Strategies
No. 1: Diversify3 — Consider three ways to diversify to reach “enough”: diversified income streams (e.g., pension, 403(b), Social Security), diversified investments, and tax diversification with taxable, tax-free, and tax-deferred accounts.
No. 2: Consider Longevity Risk — Plan for the possibility of living longer than average life expectancy (at age 65, age 82 for men and 84.7 for women) by ensuring that you won’t outlive your savings. A Monte Carlo calculator is useful for doing this.
No. 3: Expect Changes in Spending — Know that spending tends to decrease from the go-go years (age 65-74) to slow-go years (age 75- 84) before rising again at age 85 and beyond. Understanding this can help you make better plans to reach “enough.”
No. 4: Save 1% More — Kick your savings up a notch when income increases or household expenses end (e.g., child care or a car loan). Just saving 1% more of pay over 25 or 30 years could result in tens of thousands of dollars of additional savings.
No. 5: Know Your RLE — Calculate residual living expenses (RLE) by subtracting guaranteed income streams (e.g., pension) from the amount projected annually for living expenses and taxes. Use this number to calculate “enough” savings.
No. 6: Get Serious in the “9th Inning” — Take “fine tuning” steps to prepare for retirement when you are 3-5 years out. Examples: getting current pension/Social Security estimates, investigating retire health insurance options, and a pro forma budget.
In Summary
There is no “cookie cutter” approach to financial planning for retirement. People are different with unique interests, goals, and expectations. The best way to determine if you have saved enough money to retire is to define the lifestyle that you want to live and use one or more of the ten “enough” metrics described above.
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Dr. O'Neill is the owner/CEO of Money Talk: Financial Planning Seminars and Publications where she writes, speaks, and reviews content about personal finance. She is a Distinguished Professor Emeritus at Rutgers University and a long-time 403(b) plan participant.