We find ourselves in the middle of one of the greatest wealth transfer periods of all time. Those with wealth must decide whether they want to make transfers, and if they do, they must decide how much, to whom, when and in what structure?
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Marlena Lee and Massi De Santis, both of Dimensional Fund Advisors, recently published their research titled “How Much Should I Save For Retirement.” 1t attempts to solve both of these ubiquitous questions. They summarized their findings in their paper, and we will summarize it below.
According to Lee’s and De Santis’ research, after accounting for both fluctuations in income over a working career and uncertainty of investment returns, if you would like to replace 40 percent of your income with a 90 percent probability, you need to save 13.2 percent of salary if you start at age 25, 15.4 percent if you start at age 30 and 19.2 percent if you start at age 35.
These savings percentages reflect a constant savings rate over your working career depending on the age you start saving. These savings rates look overwhelming whether you start at 25 or 35, which is why Lee and De Santis came up with an alternative approach to increase savings as salary increases over your career to replace 40 percent of your income with a 90 percent success rate. The savings ranges from 2.2 percent of salary for less than $25,000 to 26.4 percent of salary for household salary above $180,000.
For example, if you are making $65,000 per year, you should be saving 11 percent of your salary. If the total annual household income is $155,000, then the savings should be 23.7 percent of salary or $36,735 per year. On a household level, this suggested annual savings amount is close to the maximum 401(k) contribution limit for two workers younger than age 50 ($17,500 per person in 2013) and less than twice the annual contribution limit for two workers age 50 and older contributing the maximum to their 401(k) plans ($23,000 per person in 2013).
If you work for an employer and they offer a retirement plan, you should take advantage of the retirement plan – regardless of employer matching of employee contributions. If the employer offers a match, there is little reason to not participate and save at least up to the match from the employer. Remember, you are responsible for your financial success. If you have a wealth manager, they can help motivate you to save, but you ultimately control your level of savings – and spending. One savings technique we often suggest to clients is every time you get a raise, you put the entire raise into your retirement plan.
In Lee’s and De Santis’ research, they calculate target asset/income multiples for different ages. They found that for a 40 percent replacement rate and a 90 percent probability of success, you should have accumulated 1 times salary at age 35, 3.75 times salary at age 45 and 7.5 times salary at age 55. We interpolated the age 65 number to be 10 times salary.
For example, if someone makes $100,000, they should have accumulated $100,000 at 35, $375,000 at 45 and $750,000 at 55 and $1 million at 65. Even if you are on track, there could be other opportunities you are missing such as mitigating taxes, creating a tax-efficient portfolio and making sure your estate plan is updated.
For lower salaries, Social Security should provide a great supplement to retirement savings. For higher individual salaries, savings rates might need to be higher since Social Security becomes capped. These are general rules of thumb and your circumstances and situation may be different. You should always seek professional advice when planning for retirement.
Robert J. Pyle is president of Boulder-based Diversified Asset Management Inc., an investment adviser registered with the state of Colorado. This column reflects the writer’s views and is not a recommendation to buy or sell any investment. It does not constitute investment advice. Contact Pyle at 303-440-2906 or firstname.lastname@example.org.