How Much You Need to Save for Retirement

How much money does a typical worker need to save every month in order to have a reasonable chance of financing a secure retirement? New analysis from the Center for Retirement Research at Boston College (CRR) came up with a broad overview of the rates needed by different age groups and income levels.

To estimate necessary savings rates, the researchers first sought to determine what level of retirement income would provide an equivalent standard of living to a retiree's final year of pre-retirement income. After they took account of changes in various tax burdens, commuting expenses, housing costs and other factors, they estimated that a single worker earning $20,000 prior to retirement (the CRR study's "low" income) would need about 88% or $17,600 during retirement, including Social Security benefits calculated according to the current formula. Someone earning $50,000 ("medium" income) would need about 90% or $40,000 after retirement, and someone earning $90,000 ("high" income) would need about 81% or $73,000. Both of those estimates also assume the current levels of Social Security benefits. 

Here's how the projected savings rates work out for a consumer at each level, assuming a normal retirement age (67) and an average annual investment return of 4% after inflation is taken into account:

A low income retirement saver would need to set aside 8% of income each years starting at age 25. If the same person were to wait until age 35 to start, the rate would go up to 12% of their income per year. If the same person were to wait until age 45, the necessary savings rate would rise to 20% per year.

A medium income retirement saver starting at age 25 would need to set aside 12% per year. Waiting to start until age 35 to start the savings boosts the rate to 18%. Waiting until 45 pushes it to 31%.

A high earnings saver would have to set aside 16% per year starting at age 25. If he or she waited to start until age 35, the rate would increase to 25%. Waiting until 45 causes the required savings rate to rise to 42%.

Keep in mind that if Social Security were to be cut back, savings rates would have to be increased proportionately to cover any reductions in anticipated benefits. Also keep in mind that if real investment returns average higher than 4% in the future, the amount of savings can be reduced somewhat. But the researchers noted that "...the effect of rate of return on required saving rates, for workers at all earning levels, is smaller than the effect of the age at which saving starts and, especially, the age of retirement." In other words, start your savings program earlier and then working longer could have the greatest impacts on your financial readiness for retirement.

Investing Through Life’s Stages

Investing is a lifelong process. The sooner you start, the better off you'll be in the long run. It's best to start saving and investing as soon as you start earning money, even if it's only $10 a paycheck. The discipline and skills you learn will benefit you for the rest of your life. But no matter how old you are when you start thinking seriously about saving and investing, it's never too late to begin. The first part of a successful lifelong investment strategy is disciplined savings habits. Regardless of whether you are saving for retirement, a new house, or just that extravagant dining room set, you will need to develop rigid savings habits. Regular contributions to savings or investment accounts are often the most productive; and if you can automate them, they are even easier.

Factors That Affect Your Investment Decisions
Once you begin saving on a regular basis, you'll soon have to decide how to invest the money you are saving. Regardless of what financial stage of life you are in, you will have to decide what your needs are and how comfortable you are with risk.

Growth or Income
What do you need the money to do? The answer to this question will help determine whether you want to put your savings into investment products that produce income for you, or that concentrate on growing the value of your investment. For instance, a retirement fund does not need to produce income until you retire, so your investing strategy should focus on growth until you are close to retirement. After you retire, you'll want to draw income from your investment while keeping your principal intact to the extent possible.

Time and Risk Tolerance
All investing involves a certain amount of risk. How well you tolerate price fluctuations in your investments will need to be balanced against your required rate of return in determining the amount of risk your investments should carry. An offsetting factor to risk is time. If you plan to hold an investment for a long time, you will probably tolerate more risk because you have the time to make up any losses you may experience early on. For a shorter-term investment, such as saving to buy a house, you probably want to take on less risk and have more liquidity in your investments.

Sound Strategies for Everyone
Everyone lives his or her life differently, and everyone has complicated emotions about money, so investment decisions are highly personal and unique to each person.
But there are some basic rules that apply to most investors.

• To provide liquidity for emergencies, you should probably always have a cash reserve in a money market fund or traditional savings account or CD, no matter what your life stage.

• Also, if you can tolerate even a little risk, you should probably always have some portion of your portfolio in stocks to help protect your savings from being devalued due to inflation.

• Another good idea is scheduling regular reviews of your investments with a financial advisor. This habit will keep you up to date on your investments and help spot potential problems in your investment strategy. Finally, every investment decision should include tax considerations. Investments can be taxable, tax deferred, or tax free. You should be aware of the taxable status of your investments and take that into account when setting up and reviewing an investment strategy.

Investing for Life Stages
Although everyone's attitude toward investing and money is different, most investors share some common situations throughout their lives. For instance, where you are in your life cycle certainly affects how you invest for retirement, but what about other life stages that aren't so closely related to age? Let's say you're 40 and expecting your first child. You'll need to decide how to balance your finances to account for the additional expenses of a child. Perhaps you'll need to supplement your income with income-producing investments.
Moreover, your child will be entering college at about the time you're ready to retire! In these circumstances, your growth and income needs most certainly will change, and maybe your risk tolerance as well.