These 4 rules that can help determine if your retirement planning is on track
Are you on track for a comfortable retirement? Will you be too dependent on Social Security? Four rules of thumb analyzed by Fidelity Investments can provide helpful guidance.
Russ WilesPerhaps the most daunting financial challenge most people face is estimating how much money they will need in retirement. It's a difficult task because there are so many moving parts and unknowable variables — from estimating how long you will live to forecasting how much your investments will yield.
Fidelity Investments recently explained four key savings rules of thumb that can help provide a feel for whether you're on track. The company evaluated these guidelines for the U.S. and five foreign locales to provide comparative context and encourage successful savings habits across international boundaries.
In a lot of areas, Americans' financial literacy is much higher than it is in other nations, said Mark Sullivan, head of Fidelity's international benefits consulting group in London. Part of the rationale behind the report was to "take the best practices of the U.S. and deploy them internationally," he said.
But even in the U.S., many people aren't practicing these four guidelines and might not even be familiar with some of them:
1. How much to save each year
Fidelity's first rule of thumb is to try saving at least 15 percent of your gross income, preferably over your entire career. If you earn around $50,000 a year, not far from the U.S. median income, you would want to sock away $7,500 annually.
This amount can include employer matching funds if you participate in a 401(k)-style retirement plan at work, Sullivan said in an interview.
A 15-percent savings goal would represent a stretch for a lot of Americans. Savers in 401(k) plans managed by Fidelity currently sock away 13.2 percent on average — 8.7 percent by participants themselves and 4.5 percent chipped in by employers.
People lacking retirement coverage at work — nearly half the employed population — usually save much less. Workers can save on their own, using Individual Retirement Accounts and other vehicles, but most don't on a comparable scale.
Fidelity's recommendation of a 15-percent goal for Americans is near the middle of the pack as a global comparison. Fidelity encourages workers in Germany to save 21 percent and Hong Kong residents to save 20 percent.
In Hong Kong, for instance, longer life expectancy and earlier retirement ages make it critical for workers there to save more than in the U.S., Sullivan said. Other key factors that vary across borders include investment returns available in local markets and the generosity (or lack thereof) of government pensions.
Suggested savings rates for the three other nations evaluated by Fidelity are: 16 percent in Canada and Japan and 13 percent in Great Britain.
2. Savings as a multiple of salary
Another way to approach retirement planning is by calculating the total amount of money you might need to save.
Rather than pick a number out of the blue, Fidelity recommends that Americans strive to accumulate at least 10 times their final yearly salary. Someone who earned $50,000 in that final year of full-time work would want at least $500,000 saved by the time they retired, presumably around age 67. Younger retirees would need higher amounts.
Housing equity counts toward this 10-times savings figure, making it more attainable for people who own homes. Homeownership is less common in places like Hong Kong, which explains why Fidelity suggests people there save a hefty 12 times their final salary, Sullivan said.
At the low end, Japanese and British savers could get by at seven times their final-year income, while Germans and Canadians, like Americans, should strive to save 10 times.
Fidelity's study assumes that most people will spend a bit less in retirement than during their working years, though they might splurge early in retirement by purchasing a new vehicle or taking costly vacations, Sullivan said.
Conversely, they might spend a lot on health care, but that typically comes later in retirement. In general, other costs such as for food, gasoline and entertainment tend to decline during retirement.
3. How much can you safely withdraw?
This indicator puts retirement planning into the context of both spending and investment performance. Fidelity suggests that Americans withdraw no more than 4.5 percent of their savings each year to make ends meet in retirement — if they want to keep their nest eggs more or less intact.
So if you have $500,000 saved up, you could safely withdraw about $22,500 yearly, supplemented by what you get from Social Security.
One assumption here is that retirees hold most assets in bonds and other fairly stable fixed-income instruments — and not too much in stocks or stock mutual funds. Equities are great for generating long-term growth, which even young retirees need, but stocks are much more volatile.
If you withdrew even 4.5 percent from a stock-based portfolio during a sharp down year, it could blow a sizable hole in your portfolio that could take years to mend.
The sustainable withdrawal rates suggested by Fidelity range from 3.9 percent in Japan to 5 percent in Great Britain. The other recommended rates are 4.1 percent in Hong Kong, 4.5 percent in Canada and 4.6 percent in Germany.
4. What about income replacement?
The fourth guideline from Fidelity estimates how much of your spending in retirement should be met with personal savings, as opposed to Social Security or similar government plans in other nations.
Americans should try to amass enough savings (including employer pension income, if any) to cover at least 45 percent of their retirement spending, with Social Security covering the other 55 percent. This assumes people will want a retirement lifestyle similar to what they had while working.
Americans are near the middle of the pack in this measure. People in Britain and Japan can get by with personal-savings rates of 35 and 36 percent, respectively, with government pensions taking care of the rest, according to Fidelity.
Like Americans, Germans and Americans should strive to meet at least 45 percent of their retirement spending from savings, while Hong Kong residents might need 48 percent.
Americans who haven't compiled much in the way of personal savings will be more reliant on Social Security. One way to bolster Social Security income is to defer taking it. Monthly benefits rise each year you wait from age 62, when Social Security may first be claimed, until 70, when maximum payment amounts are set.
A Social Security Administration study estimated that about half of Americans 65 and up rely on program benefits to meet at least 50 percent of their household income, but a quarter of older adults are much more dependent, relying on Social Security for 90 percent or more.
Too much dependence is dangerous, especially as Social Security faces funding shortfalls — and possible benefit cuts — down the road.
More information about the four retirement rules of thumb and six-nation international comparisons can be seen in the newsroom section of fidelity.com or here.
Reach Wiles at russ.wiles@arizonarepublic.com or 602-444-8616.
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