How much does the average person need in savings to retire? We’ll explore various scenarios, but make sure to read until the end for some positive findings from a recent study.
Assumptions
When we are running these scenarios, it is important to clarify our assumptions and the data we use. The quality of the results depends upon the assumptions and inputs. Bad data in, bad data out. For this example, we’re again taking a simple, quick approach.
For our initial scenario, we will assume a retirement age of 65. This age represents the earliest point at which any individual can apply for Medicare benefits. Additionally, this assumption aligns harmoniously with the demographic data obtained from the Bureau of Labor Statistics’ published report.
Let’s assume an inflation rate of 3% and expected portfolio returns of 7%, which are pretty standard assumptions when running these types of calculations. Whether or not you agree with these assumptions given the current market valuations and inflation data is up to you.
Now, let’s look at the expenditures of the average American during retirement. According to the Consumer Expenditures survey by the Bureau of Labor Statistics, individuals aged 65 and older spend an average of $47,579 annually, which amounts to $3,965 per month. Spending tends to decrease throughout retirement. Early retirees may exceed this amount, while older retirees may spend less.
Shifting our focus to Social Security, the average retirement benefit, as reported by the Social Security Administration in September 2021, stands at $1,515. Taking into account the BLS survey data, the average household of individuals aged 65 or older comprises 1.7 people. Hence, we’ll assume that one spouse receives $1,515 per month, while the other receives 70% of that amount, equivalent to $1,061.
Lastly, let’s address portfolio income. Once again, we’ll apply the 4% Rule to determine the necessary portfolio size for our average American retirees to sustainably support their withdrawals. While the 4% Rule may have its critics and limitations, it serves our purpose well for these estimated calculations.
Retirement at age 65
Let’s assume, for our first scenario, a retirement age of 65. Since retirement is imminent, there is no need to account for future growth or additional contributions to their portfolio. This simplifies the calculation and provides us with a solid starting point.
To determine the amount our hypothetical couple needs to withdraw from their portfolio, we begin by subtracting their Social Security benefits from their total living expenses. This reveals a monthly shortfall of $1,389, which must be met by their investments. In other words, they require an additional $16,673 per year.
Applying the 4% Rule, we divide $16,673 by 4% to ascertain their total portfolio requirement of $416,825. If our retirees have this amount saved, they are well-prepared for retirement. However, if they fall short, it may be wise for them to consider postponing their retirement plans.
Retirement at age 60
Rather than assuming a retirement age of 65, let’s consider a retirement age of 60. This adjustment allows for more time for their investments to grow and for them to continue saving for retirement. Now, the question is, how much progress can they make in five years?
In this scenario, we will perform the same calculations as before, but with the inclusion of growth and savings. Additionally, we cannot overlook the impact of inflation on their living expenses.
For retirement in five years, our retirees’ monthly living expenses will rise to $4,596 due to inflation. Fortunately, Social Security benefits do increase annually with a Cost-of-Living Adjustment (COLA). To simplify matters, let’s assume that their Social Security payments also increase in line with inflation.
Even with these adjustments, there is still a shortfall of $1,611 per month that needs to be covered by their investments. Considering the 4% Rule, our couple will now require a total of $483,214 in five years.
By making these adjustments and accounting for various factors, we can better understand the financial landscape our retirees will face as they approach retirement.
Assuming a starting retirement savings of $275,000, our couple has made commendable progress. With an anticipated 7% annual growth on their investments, their retirement portfolio is expected to reach $385,702 in five years.
However, there remains a shortfall of $97,513 that they need to accumulate within the same timeframe to cover typical retirement expenses for the average American. To achieve this, they would have to save $1,362 per month, totaling over $16,000 per year. While attaining this savings target is challenging, it is indeed possible.
Let’s acknowledge the couple’s determination in their retirement planning journey thus far while recognizing the importance of continued diligent savings to bridge the gap.
Retirement at age 55
Let’s assume a retirement age of 55 years old instead of 60. If everything else remains constant, how would this impact the outcome?
Due to inflation, the annual portfolio withdrawals would increase from $1,389 per month to $1,867 in ten years. The compounding effect of 3% is truly remarkable, isn’t it?
Applying the 4% Rule, our couple would now require a retirement portfolio of $560,178 in ten years. Assuming they currently have $275,000 earning 7%, their investments would grow to $540,967 by the time they retire. However, there is still a shortfall of $19,211 between what they will have and what they will need.
To bridge this gap, our couple will now need to save approximately $111 per month for retirement. This amounts to $1,332 per year, which is certainly an achievable goal.
How Much Do You Need to Save for Retirement?
Naturally, these numbers are merely derived from a limited dataset, representing averages. However, we can introduce more intricacy into our assumptions regarding investment returns, inflation, and a sustainable withdrawal rate.
It’s crucial to acknowledge that due to inflation, the amount required for retirement surpasses most individuals’ expectations. This is why inflation has become a prominent topic of discussion lately. As time passes, our investments must diligently labor on our behalf to secure a prosperous retirement.
Fortunately, amidst this data, there is encouraging news. According to the Bureau of Labor Statistics, households in the survey exhibited an average after-tax income of $50,133 per year. Hence, on average, consumers are effectively managing their finances. It’s highly probable that many of them possess a pension or other sources of income that aid in bridging the gap.
Of course, no one is average. If you need help figuring out how much you’ll need to save for retirement, then click here to set up a quick, complimentary introduction call to see if Einstök Wealth Management is a good fit. We do still have the capacity to take on new clients.
As a fee-only financial advisor in Southern California, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.