Retirement: You'll need far more than you think
We're already not saving enough. But new research indicates we've been underestimating our retirement income needs.
By Jeanne Sahadi, senior writer

NEW YORK ( -- What you thought you needed to save for retirement may not be enough.

When the question of retirement savings comes up, the typical thinking has been that your savings plus Social Security and any pension you'll get should provide you with at least 70 percent of your pre-retirement income.

That rule-of-thumb replacement rate is based on the average needs of all retirees and it's okay as far as it goes, especially if it spurs you to start saving, which wouldn't be a bad thing considering a majority of workers between 45 and 54 have less than $50,000 in savings.

But it doesn't factor in four key elements that have a direct bearing on how much you -- not the "average" retiree -- should save today to insure you have adequate income in retirement, according to Employee Benefit Research Institute Fellow Jack VanDerhei, who is working on developing a more realistic way to assess your retirement needs.

Specifically, his methodology takes into account:

  • Your potential for a health crisis in retirement
  • The spending habits of retirees who are generating the income you want your nest egg to generate (e.g., more than $40,000). In separate research, EBRI found that a majority of retirees say they spend 95 percent or more of their pre-retirement income.
  • Your longevity risks
  • Your investment risks

In addition, VanDerhei, also a business school professor at Temple University, factors in two more elements that aren't usually accounted for:

  • The effect of annuitizing a portion of your nest egg when you retire, to insure you receive a steady source of income for life.
  • What you must save to achieve a 50 percent, a 75 percent and a 90 percent chance of reaching your goals. Most retirement savings calculators approximate a 50 percent probability.

VanDerhei's calculations tell you how much you need to save today to insure you have adequate retirement income. That's defined as having enough money to comfortably spend the way retirees in your desired income group spend, to weather the high costs of potential health crises and to not outlive your money.

So, for example, say you're a 40-year-old woman, making $70,000. You've already saved $50,000 for retirement and you want to retire at age 67.

According to VanDerhei, if you want a 90 percent chance of having adequate retirement income, you should save 26 percent of your income every year.

If that recommendation seems steep, it is, especially considering most people typically save less than 7 percent of their income in their 401(k)s.

But you may not have to come up with the full 26 percent yourself if your employer matches your 401(k) contributions.

Or, if you're willing to work part-time in retirement and earn the equivalent of $10,000 today then you'd only need to save 20 percent, including company matches.

If you're comfortable with just a 75 percent chance of achieving your goal, you'd only need to save 11 percent if you're not going to work in retirement, or just 6 percent if you do.

These calculations assume that if you want a high probability (90 percent) of achieving your goals that your investments generate a 7 percent average annual return until retirement, that you annuitize three-quarters of your nest egg when you retire, and that you only put 25 percent of the money left over into stocks.

If you're shooting for 75 percent probability, the assumptions are the same except that after you annuitize three-quarters of your nest egg, you invest all of the money left over in stocks.

So what about replacement rates?

In the example above, if you wanted a 90 percent probability of having adequate retirement income you'd aim to replace 108 percent of your $70,000 income. If you'd be satisfied with a 75 percent chance, you'd aim to replace 72 percent.

The replacement rates would be much higher if you didn't annuitize a large portion of your nest egg. (See how annuities work.)

Consider a man who wants to retire at 65 and expects to have more than $40,000 a year in retirement income. If he wants a high probability of having adequate income until he dies, he should plan on replacing 89 percent of his pre-retirement income, assuming he annuitizes three-quarters of his nest egg. If he doesn't, he should aim to replace 119 percent.

In any case, those are far cries from the rule-of-thumb 70 percent.


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