Safe Savings Rate — What Percentage of My Income Should I Save for Retirement?

By Dr. Jim Dahle, WCI Founder

A safe withdrawal rate is the percentage that you can withdraw from your portfolio each year in retirement, adjusted for inflation, at which you shouldn't run out of money before dying. But how much of your income do you need to save for retirement?

Wade Pfau, a finance professor, published a paper in 2011 in which he discussed the concept of a safe savings rate.

How Much Do I Need to Save for Retirement?

Many years ago, a WCI reader posted a comment asking how much he needed to save each year in the accumulation stage of his life. Although the answer I am tempted to give is “as much as you can” (which is probably accurate from a behavioral perspective), the answer, from an academic and theoretical perspective, is that “it depends.” But Pfau's paper nails it down about as well as one can.

The real meat of the paper is Table 1, which I've reproduced here.

Let's look at the two extremes to get an idea of what the table is saying. First, if you work and save for 20 years and then want to live in retirement for 40 years on 70% of the salary you were making when you were working—and you're only willing to use a portfolio that is 40% stocks—you need to save 66% of your income each year. On the other hand, if you're willing to work for 40 years, have a retirement of 20 years, live off 50% of your final salary, and use an 80/20 portfolio, then you only need to save 6.3% of your salary.

There's obviously a big difference between 6% and 66%. Most of us are probably somewhere in the middle. A more reasonable assumption is 30 years working, 30 years retired, living off 50% of your final salary in retirement (remember you no longer have to pay as much in taxes or save for retirement and you'll likely get something from Social Security), and use a more standard 60/40 portfolio. This reveals that you need a savings rate of 17% (of your gross income).

More information here:

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How to Start Saving for Retirement

My Safe Savings Rate Recommendation

This is the basis for my usual recommendation to save 15%-20% of your income. Ten percent probably isn't enough, and 25%-30% is for those who want to retire early. If you want to retire really early (before age 50), you'd better be pretty darn thrifty before and after retirement. Even with only living off 50% of your salary (remember Social Security won't kick in for a decade or more after you retire) and investing aggressively, you'll still need to save over 1/3 of your income during your working years.

The Importance of Increasing Your Savings Rate

For a “young” investor (meaning one who has a low account balance relative to the amount that person will need to retire—say a ratio of 25% or less), their savings rate has a much greater effect on the amount of money they will have to spend in retirement than their return. Rather than focusing on how to eke out a few more percentage points of return, they would be much better off focusing on increasing their savings rate.

Here's an example:

An investor with $10,000 who saves $5,000 a year expects to have $167,000 15 years from now if they pull off an 8% per year return. If they can increase that return by 1%, they would have a total of $182,000. If they could increase their savings by just $2,000 per year, they would end up with $222,000. They would get much more “bang for the buck” by saving more rather than trying to get a higher return.

The opposite is true for a “mature investor” (defined as someone with a high percentage of what they would need to retire on). Let's say we have a 60-year-old investor with five more years until retirement. They have a nest egg of $1 million. They are currently saving $20,000 per year and expect an 8% return from their portfolio. This will only get them to $1.59 million. Where is the bang for their buck now? If they saved another $5,000 per year, they would end up with $1.62 million. But if they could increase their return by 1%, they would end up with $1.66 million. Clearly, the bang for their buck is in maintaining/increasing their return.

More information here:

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How to Increase Your Savings Rate

The following are some steps you can take to increase your savings rate.

Increase the Amount of Money You Make

It is much easier to save 25% of $200,000 than it is to save 10% of 40,000, even while paying a higher tax rate. This can be accomplished by further schooling/training to upgrade your skills, changing jobs when opportunities to make more money arise, and taking additional jobs and working overtime.

Save Your Raises

Cost of living and standard raises are frequent with many jobs. Although we often need to gradually increase our spending to maintain our lifestyles, oftentimes we do not need to increase our spending as much as our income has increased.

Keep Fixed Expenses Low

The less you are obligated to spend, the more you have the option to save. Then, you can make conscious decisions between spending and saving each month. Avoid contracts you can’t get out of if your finances turn sour—such as cable, cell phone, boat payments, large mortgages, etc. Try to rent your lifestyle when possible rather than buy it.

Limit the Cost of Your House and Cars

Most people calculate their mortgage payment when they opt for a bigger, nicer house, but they forget that they also have to pay more in taxes, utilities, repairs, landscaping, furnishings, and upgrades. Because your house is a big-ticket item, saving 25% on that will free up much more cash flow than eating out 25% less. To make it worse, most of these expenses are fixed expenses.

Likewise with cars, a great deal of money is lost buying and financing these depreciating assets. The older you buy a car, the less you will pay in financing costs, depreciation, insurance, and sometimes even repairs because you may be less likely to repair unimportant features of an old car, like dings in the bumper or a power mirror that works poorly. The savings in repairs and gas of a new car do not come anywhere close to overcoming these costs.

Watch Out for the Latte Factor

Even small costs can add up over time, especially when considered in light of decades of compounding. The classic example is the $5 latte. If you save that $5 a day ($180 a month, $1,825 a year) and earn 8% per year on it, it will be equal to $482,000 in 40 years. Consciously decide what you want to spend your money on, and spend it on that which brings you the most happiness. Save the rest.

Calculate your savings rate each year. Studies show that we consciously and subconsciously strive to improve in those aspects which we measure.

What percentage of your income are you saving? Has it gone up or down as you get closer to retirement?

[This updated post was originally published in 2011.]

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