Saving for retirement is too often a patchwork quilt ranging from doing nothing to thinking about it, but ending up doing nothing. Life is always a question of current priorities. No doubt, everyone would agree that saving for retirement is extremely important. People would also tend to agree that it is important to lose weight or to quit smoking. Still, these two tasks are very easy to put off or avoid altogether. A couple gets married, has children, buys a house and furnishings, needs a new car, joins a club, buys a boat, takes vacations and so on. There is really never a convenient time for most people to start saving for retirement in a serious manner. It is far easier to think about it "tomorrow."  However, the sooner one starts saving the lesser burden it will be throughout life. It is not simply a question of saving ... it is important to save enough.

How much is enough?

Social Security

There is a common belief that younger people will not be able to count on ever receiving any payments from Social Security. It is believed that the system is going broke.  However, it seems unlikely that Social Security will disappear. What may happen is that individuals will pay into the system but never receive the expected payouts by way of being "means tested" out of some, or all, of the expected Social Security payments.  

Of course, it would seemingly be a type of fraud to pay in on the expectation of receiving benefits to later see those benefits stripped away, or reduced, by federal legislation. There are those who espouse that "sharing the wealth" is only fair.  The point here is that it is now prudent for each person to take serious responsibility for his/her own retirement savings.

Assumptions

Some simple assumptions are made herein to demonstrate the percent of gross (pre-tax income one needs to save each year (at different starting ages) so as to allow one to be able to receive 70 percent of the gross (and net) income of the final working year to live on in the first year of retirement.  Retirement is assumed at age 65. Four different "start saving" ages are examined:  25, 30, 40 and 50.  Regardless of what your current gross (pre-tax) salary is the model assumes that the salary grows at 5 percent per year (i.e., 1 ½ percent above the assumed inflation rate of 3.5 percent per year) from the start age to retirement at age 65.  

While the goal is to be able to have 70 percent of your final work year gross (and net) salary available in your first year of retirement, that first year number will be assumed to grow at the inflation rate (3.5 percent) over the following 29 years for a total of 30 years in retirement.  The investment return will be a variable between 5 and 10 percent per year in the chart below during the working years. The overall tax rate is assumed at 34 percent (federal plus state) both while working and in retirement. 

The investment return during retirement will be assumed to be 6.5 percent per year with a possible mixture of stocks, bonds, money market, etc.  


Three additional things must be considered:

First, it is assumed that all of your savings will be invested in tax sheltered vehicles such as IRA's, 401K's, etc. This could well be an optimistic assumption given limitations on how much one can actually invest tax sheltered.  

Second, your employer might put some money directly into one of your plans. You could reduce your own savings accordingly, if this is the case.  

Third, Social Security, if received, could be a very meaningful part of your retirement resources. Thus, the above-mentioned number of 70 percent of final working income could approach, or even exceed, 100 percent in the first year of retirement. One slight wrinkle here is that the Social Security "full retirement" age is creeping up above age 65.  

Savings required

Using our proprietary Retirement Spending Model, the savings rate is calculated so that your funds last through 30 years of retirement. At this point the chart should be largely self-explanatory.  See that if one starts saving at age 25, the savings rate needs to be slightly over 11 percent of gross salary for each year out to retirement if the investment rate of return is 10 percent per year. With lower rates of return, the savings rate required becomes progressively higher.  

Starting the savings at a later age results in progressively higher required savings rates.
 
Summary

This model is simplistic and cannot take into account all of the financial twists and turns in life.  Still, it is valuable in that it vividly demonstrates the vital need to start saving early and consistently. Amazingly, many people could have significantly more money available for retirement savings with slight changes in lifestyle.   

Consider eating out less often (lunch and dinner), give up gourmet coffee houses, truly give up smoking, rent videos instead of going out to expensive movies, etc... 

The amount of pre-tax money that some people spend on these and other unnecessary things is quite significant. Eliminating just a few such things could go a long way toward meeting your retirement savings goals.  Still, it should be noted that most people seemingly get by in retirement somehow. The big issue gets down to "quality of life" in retirement ... skimping versus doing some things that you really want to do when retired.   
 

R. Stewart Eads, CFA, is president of Eads & Heald Investment Counsel and co-founded the firm in 1987. He has an MBA from Wharton Graduate School, and BEE and MSEE degrees from Georgia Tech. He was a senior portfolio manager with Wellington Management Company for 15 years. Before that, he was with the Investment Department at The Hartford Insurance Group. He also has worked in the Office of the Director, U.S. Central Intelligence Agency, and as a NASA engineer.