How much should you have in retirement by 45

"How Much Should I Have Saved By 45?" 

This is the first post in a series, where I answer questions people have on Early Retirement, Financial Independence, and Overseas Living. If you have a question you would like input on, leave me a message in the comments below this article.

COMMUNITY Q & A

“What should be the size of a retirement account at the age of 45 if you plan to retire around 65?”

Rich Madhok, 25 Sep 2019

Quora Link

You are the only person who can answer how you much you need for retirement.

I get it. Estimating how much money you need to retire is a burning question on lots of minds. The problem is the answer is unique to YOU and is based on a several factors. Significant factors like: When do you plan on retiring? Personal ones like: What kind of lifestyle do you want to live when you get old? Family-related ones: Do you have a partner that you will be supporting financially? To macabre questions like: When do you plan on dying?

81% of Americans say they don't know how much money they'll need in retirement.

Let's take a look at some benchmarks to help you estimate how much you should have saved: 

Some benchmarks are based on what expert studies think you will need

• Schwab Retirement Plan Services: $1.7 million
• Merrill Lynch Retirement Study: $738,400

Other benchmarks are based on a factor of your salary

• Presidential Candidate Elizabeth Warren: 20% of Salary 
• Fidelity Investments Salary Milestones: 10 x Current Salary at age 65
• 80% of Salary of Final Annual Salary Per Year

The reality is because there are so many factors, even experts cannot agree on a proper benchmark. The best way is to make a personalized retirement budget with your best assumptions. This budget is detailed and complicated task that I do not suggest people do right away. Why do I recommend delaying this critical step? Because it takes a significant amount of time and lots of research and information to calculate. Because it’s hard means most of you will likely put it off. Which means you will likely delay saving for retirement.

DON’T DO THAT. Start saving NOW. TODAY. We can make adjustments to your savings plan later, but it’s essential to start the habit of savings. It’s human nature to put off the difficult tasks, but delaying starting your savings can have a significant impact on how difficult it will be to retire.

Assumes a 7% return on investment

Let's look at Susie. She is 25 years old. She doesn't know how much she should have saved yet, but decides to start her retirement savings by contributing $300 to her retirement account every month. By age 65, Susie will have saved over $787,000.

Mark isn’t sure how much he should have saved, so he delays saving. He doesn’t start saving until 5 years after Susie. He contributes the same $300 per month, and he retires at 65, the same age as Susie. Mark's 5-year delay cost him $247,000 in lost savings. Susie has 46% MORE money to spend in retirement.

When it comes to retirement savings, the SINGLE most important step is to start saving NOW

We will cover the exercise of how to better estimate your retirement needs in a future article, but for now let’s use a benchmark to get started.

How Much Will I Need to Retire? You will need $1,333,411 at age 65.

To answer Rich’s (Quora user) question, I used two studies (Fidelity and Merrill Lynch) to back into a calculation for his answer. 

STEPS:

1. 1

   Merrill Lynch’s study estimated that the average retirement would cost $738,400. This cost is in TODAY’s dollars. Since the Quora question is looking into the future (Assuming Rich is 45 today and is retiring in 20 years), we need to account for inflation of roughly 3% per year. The inflation-adjusted retirement savings required in 2039 is $1,333,411.

Benchmark: How Much Should You Have Saved At What Age

Retirement Milestone = X Times Annual Salary

1. 2

   The Fidelity Benchmark is to have saved 10 X your annual salary by retirement. If we use the $1,333,411 we calculated above, then estimated salary required at age 65 is $133,341 ($1,333,411 divided by 10).

2. 3

   Assuming Rich’s salary is adjusted each year for inflation, then Rich’s estimated salary at age 45 is $73,234. Going back to the Fidelity Benchmark we see that Rich should have 4 X is annual salary at age 45, which equals $292,936

How much money can I spend each year? Starting at 65, you can spend $53,336 per year.

1. 4

   $1,333,411 x 4% = $53,336

What's the Deal with the 4% in Step 4? The 4% Rule

One of the scariest things is to run out of money once you retire. Imagine the stress of trying to find a job after you have been out of the workforce for ten years. Imagine what would jobs would be available to you at 75. Imagine what your 75-year old body will feel like getting out of bed after a 10-hour workday. What about if you can’t get a job because of health, lack of job opportunities, or age discrimination? Imagine having to live for ten more years after you’ve already run out of money. Don’t outlive your savings. It will not be pleasant.

To ensure you have enough money banked at retirement to generate the annual income you need to live, many FIRE advocates follow the 4% Safe Withdrawal Rate Rule (SWR). This rule states that if you can live off of 4% of your initial retirement savings, it is doubtful you will run out of money. 

This rule is based on a study by professors at Trinity University. The 4% SWR assumes a 7% return on investments (after taxes and inflation), no additional retirement income (i.e., Social Security), and 30 years in retirement

Note that the 4% is calculated against the total of your retirement savings in the FIRST YEAR ONLY. You will calculate your budget for years 2 onward by adjusting for inflation from the previous year's amount. You do not keep using 4% of your retirement savings each year after year 1.

I personally follow a variation of the 4% rule. Why I don’t follow it explicitly and the pros and cons of the 4% rule, regarding Early Retirement is another article I will address in the future. 

What kind of lifestyle can I enjoy in retirement? It depends.

For fun, let’s find out what retirement life is like on $53,336 (Rich’s 4% SWR calculated on Step 4). First, $53,336 is in 2039, as with previous amounts from the future.

1. 5

   To get a better idea of what you can buy with $53,336, you need to adjust the amount back to today’s (2019) dollars.

2. 6

   Using the same 3% annual inflation assumption, the 2019 adjusted amount is $29,294 a year or $2,441 per month. 

$29,294 does not seem like a lot. It’s about the average after-tax income for someone working in the US today. Median net income for working people calculated by the Social Security Administration for 2017 is $31,561. So your $29,294 is pretty darn close to the median personal income of the US. There is a bit of good news for you though, people working still need to save for retirement. YOU are already retired and don’t need to save a dime. You are free to spend all your money without worries.

Let’s see what that your retirement lifestyle looks like on $29,294 annually or $2,441 per month. According to the EBRI, people age 65-74 spend their retirement budget in the following categories.

$2,441 can be poverty level in a High Cost of Living (HCOL) city like San Francisco but could be very comfortable in areas with a Low Cost of Living (LCOL).

In a LCOL state like Massachusetts, the average monthly expense for necessities (defined by GoBankingRates as housing, food, transportation, utilities, and healthcare) is only $1,409. With your budget of $2,441, you would have over $1,000 of additional spending for entertainment, drinks, social life, and other discretionary activities. Woohoo!!!! Party Time!

*WARNING* The average person in their 40s is nowhere near $292,936 (calculated on Step 3). The average retirement savings for someone in their 40s in the US is only $64,000. This means that most 40-year olds in the US only have 20% of the necessary savings to be on track to retire properly.

What We Have Learned About Estimating Retirement Savings?

• Answering the question, How much should I have saved by retirement is a very personalized question with several factors. 
• Even the experts argue on what the best benchmark is
• Start saving TODAY! Even waiting 5-years to start can reduce your retirement savings close to 50%.
• Moving from a HCOL to a LCOL (geographic arbitrage) area can increase the spending power of your retirement savings.

What do you think of this new series? Did you find it helpful? Do you have any questions about the assumptions? Do you have a question you would like answered? Leave me a message in the comments below, and I will get back with you.