Establishing Retirement Savings Targets
This calculator provides an estimate of retirement savings targets versus age of the user. The calculator improves on an approach outlined by Fidelity Investments and needs a total of six inputs, including:
- The user’s current age and annual salary, including all sources of compensation such as incentives and bonuses
- An estimate of the annual raises received (annual percent increase) between now and age 67
- The annual contribute rate into a retirement savings plan, stated as a percentage of the annual salary
- The current amount of funds in the user’s retirement plan
- The anticipated annual return on investment between now and age 67 for the funds placed in the retirement plan
Using this information, the calculator then provides the user with the following:
- The current ratio (or salary multiplier) as well as the target ratio of retirement savings to annual salary
- The current retirement savings funds versus the target value
- The terminal savings, or savings at age 67, versus the target value
- The future ratio of retirement funds to annual salary as well as the deviation, or delta, from the target value of 10x
- The annual income from the retirement savings, using the portfolio success rule of 4%
- The user’s salary at age 67, or terminal salary
- The percentage of the terminal salary provided by the retirement funds, using the rule of 4%
Why Retirement Targets by Age?
At one time, companies offered employees pensions, and no one had to worry about planning for retirement. After forty years of service, this pension along with Social Security, provided the employee with enough income to live comfortably once retired. Unfortunately, a recession, or a bear market meant pension funds might be significantly underfunded. Companies quickly learned that pension funds make it hard to create long-term growth plans, since they were also victims of the risks that accompanied the higher returns of the stock market.
Companies began shifting this market risk to employees in the form of self-funding retirement accounts like thrift and 401(k) plans. Pension funds disappeared as companies absolved themselves of any retirement planning responsibilities. Instead, employees were encouraged to participate in these 401(k) plans and often left to guess how much money they needed in their account to live comfortably in retirement.
That’s where retirement targets by age can help. By understanding how much funds are needed at various milestones in their careers, employees could adjust the amount of money they save to their retirement account. Based on their research, Fidelity developed a simple rule-of-thumb that is easy to calculate.
Saving for Retirement
The default values for our calculator are those we found most useful for keeping the user on track to make their targets. Fidelity recommends a contribution rate equal to 15% of your salary (before taxes). They also assume a real increase in wages of roughly 1.5% per year. This translates into a 5.1% annual raise (on average, including promotions and inflation). We used these variables to solve for the return on investment, or ROI, which allows someone to hit their salary multiplier targets. The 7.4% ROI is a reasonable outcome if a substantial percentage of the retirement portfolio (70%+) is held in common stocks. We go into more detail on these variables in our accompanying article How Much Do You Need to Retire?.
Interpreting the Results of Our Calculator
The objective of this calculator is to demonstrate your progress against the targets established by Fidelity, which are reasonable and would replace 40 to 45% of your pre-retirement income. While Fidelity uses a 4.5% withdrawal rate to determine their replacement value of 45%, our calculator uses the rule of 4% to produce a replacement target of 40%. The other values calculated are used as comparatives (actual versus target). This includes the target ratio (or salary multiplier), current savings, and target savings.
One last mention about saving for retirement. This isn’t a one-and-done activity. You don’t put your future on autopilot. The idea is to check in at various points in your career and see how well you are doing against your targets. While Fidelity offers salary multipliers at five-year increments, this calculator allows you to check progress at any stage in your career.