[dropcap]I[/dropcap]n our performance-driven world what tends to get most of the attention when it comes to retirement planning is how to score the best possible return given our respective appetite for risk. To the extent retirement planning and investing ever bubbles up as a topic of conversation in your social circles, I’m betting there’s nary a convo about what you managed to sock away this year, but plenty of chatter about investment returns. Right?
But here’s the thing: your portfolio’s rate of return isn’t exactly the holy grail. The wonks at Boston College’s Center for Retirement Research did some number crunching and came to this conclusion:
[quote]“Starting early and working longer are far more effective levers for gaining a secure retirement than earning a higher return.”[/quote]
And that’s especially true the more you’re making right now. The Center for Retirement Research at BC took a look at how much of your current income you need to be socking away today based on a goal of having retirement income that replaces 80 percent of current income. While lower-earners can expect their Social Security payout to generate about 50 percent of their retirement income, for “maximum” earners (that’s someone with taxable income of $106,800 in 2011, the maximum amount subject to the Social Security payroll tax) Social Security will replace just 27 percent of their income needs if they work until age 67. Unless you’re one of the dwindling number of lucky ducks in line for an old-fashioned pension that means your personal savings will need to generate roughly 50 percent of what you’ll need to have a comfy retirement.
Will You Retire Comfortably?
The CRR at Boston College found that a max earner with the foresight to start saving in his mid 20s would need to set aside 13 percent of his salaryand earn a reasonable 5 percent annualized rate of return to end up in solid shape for an age-67 retirement. Wait until age 35 to get rolling on the retirement savings and if you still have your sights on retiring at 67 you’ll need to ramp up your savings rate to 21 percent at the same assumed return rate of 5 percent.
Sure, you can invest more aggressively to (hopefully) earn a higher return, but that’s got its obvious risk tradeoff. Even at a 7 percent rate of return you’d need to sock away 14 percent starting at age 35 to still have a shot at retiring at age 67. And if you wait until your mid 40s to get rolling on your retirement savings, you’re really going to be making life difficult. It’s unlikely you’ll have any shot at retiring at age 67, as you would need to be saving 38 percent of your salary each year assuming a 5 percent rate of return. Even if you took on more investment risk and finagled a 7 percent return you’d still need to save 30 percent of your income each year.
The far likelier outcome is that you will need to (regardless of desire) work longer and aim for higher returns. The CRR calculated that a max earner who is 45 today would need to delay retirement to age 70 and still start saving a stiff 19 percent of income today to have a shot at a comfy retirement. And that presumes the 45 year old manages to earn a real return of 7 percent. If you want to invest more prudently and aim for a 5 percent return you’d need to sock away 25 percent starting at age 45. Yikes.
Below are some eye-opening tables from the CRR that spell out the tradeoffs. It’s easy to stare at the tables and figure you’ll just fall into the ever-growing legions of folks these days who plan to work longer to make the numbers work. Sure, that makes sense, but it’s not exactly something that is within your absolute control. You can plan on working longer, but in the meantime, perhaps its time to take another spin through your finances and see if there’s also a way to boost your savings rate.
ANNUAL SAVINGS RATE NEEDED FOR HIGH-INCOME EARNERS TO REPLACE 80 PERCENT OF INCOME IN RETIREMENT
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