The Importance of Having a Retirement Savings Rate
“How much should I be saving for retirement?” It’s a basic, yet important question asked to financial advisors like myself all the time. When asked this question, I like to reframe the question a different way and say “what percentage of your income should you be saving into retirement?” A percentage gives a tangible understanding of the amount going towards retirement every pay period, scales with changes in your income, and provides a benchmark to track success. The percentage of income saved is your Retirement Savings Rate. To find the right Retirement Savings Rate for you, we must first comprehend the purpose behind a savings rate, how it is calculated, and the key factors that will determine your rate.
| What is the Purpose Behind a Savings Rate?
Most individuals have a target of when they want to retire or achieve financial independence. A Retirement Savings Rate provides clarity and vision to achieving that goal. First, percentages are more adaptable than static dollar amounts as they can be applied to any individual’s respective income. Retirement contributions through an employer are often structured as a percentage of gross pay. Additionally, data from research studies combined with financial planning analysis will help illustrate the timeframe a specific savings rate can achieve your retirement or financial independence goal.
| How to Calculate a Savings Rate?
Computing a Retirement Savings Rate is a relatively simple calculation. Start with annual Gross Income as this will be the denominator. Annual Gross Income is not your take home pay. It is your income before taxes and deductions are taken out. The numerator will consist of employee retirement contributions, employer retirement contributions, and additional retirement contributions (i.e. Roth IRA or Traditional IRA). Dividing the numerator by denominator calculates the Retirement Savings Rate.
To see this in an example, a 35-year-old individual has a $120,000 annual gross salary. He contributes 7% of gross salary into his 401(k) ($8,400) and his employer contributes 3% of his salary ($3,600). He also maxes out his Roth IRA at $6,000 per year. His Retirement Savings Rate is calculated as follows:
$8,400 + $3,600 + $6,000 / $120,000 = 15%.
| How to Select Your Savings Rate?
Determining the Retirement Savings Rate right for you depends on the answers to a subset of questions and your age. Those questions are 1) When did you start investing for retirement? 2) How much do you have saved for retirement? 3) When do you want to achieve financial independence or retirement? 4) What is your risk tolerance and risk capacity? 5) What’s the amount of monthly or annual expenses to plan on covering from retirement assets?
Answers to these questions serve as a baseline and go a long way to selecting the appropriate Retirement Savings Rate for your financial situation. As a basic example, a 40-year-old with minimal retirement assets and 22-year-old starting their career will likely have different target Retirement Savings Rate. Assuming they both will spend $70,000 per year in retirement and desire to be financially independent at age 60, the 40-year-old will likely have a higher target Retirement Savings Rate than the 22-year-old because of the 40-year-old’s shorter timeline.
A good financial advisor should be asking you the above questions and there may be more to ask based on your answers. An Embark Wealth Advisor will help evaluate your Retirement Savings Rate and ensure it aligns with your financial goals. Do not hesitate to start that conversation today.
This information is not intended to be a substitute for individualized retirement or investment advice. We suggest that you discuss your specific retirement and investment situation with your financial advisor.