American retirement savers face two big, but different, retirement challenges. Conflating them risks misdiagnosis and missing out on a potentially valuable solution that could help some retirement savers overcome both challenges.
There has been a great deal of discussion about America’s retirement savings crisis, and rightfully so. The crisis is real for a lot of Americans. The harder question may be, are you caught in the crisis? In other words, will you have enough money saved to retire (i.e., stop working for pay) and live reasonably comfortably?
Millions of Americans who lack retirement savings are squarely in the crisis’ bullseye. The wealthiest Americans plainly are not. The rest of us worry. We worry that under-saving could force us to continue working too long or, worse, cause us to run out of savings years into retirement when paid work will be too hard. Over-saving poses an equal risk: We are afraid to spend, and so we endure a worse standard of living before and after retirement.
We worry, in part, because we don’t know how much retirement savings is going to be “enough.” A majority of Americans admit they don’t know.1 And there is no single answer for everyone. Our financial positions, standards of living, savings, and goals for retirement vary too widely. Nonetheless, it is possible to figure out how much is enough for you.
Conflicting Rules of Thumb
Retirement savers reading financial advice columns orconsulting with some financial professionals are told there are one-size-fits-all “rules of thumb” about retirement savings. Their recommendation may be easy to understand and apply, but not necessarily helpful. Let’s examine two of these purported “rules.”
The 70% rule.
Some retirement planners are told their savings should produce income that, when combined with Social Security, equals 70% of their pre-retirement income. Simply, if you and your spouse earned $100,000 before taxes in the year before retirement, then you should anticipate pre-tax retirement income of $70,000. After roughly estimating that you and your spouse will receive $35,000 in annual Social Security retirement benefits, your retirement savings would need to produce another $35,000 every year for life.
For simplicity’s sake, let’s assume you buy an annuity* that generates protected income for the rest of your life. If your annuity provides a 5% annual income guarantee†, you would need to put $700,000 into that annuity to produce $35,000. So, according to this “rule,” $700,000 should be enough. A lower rate of return would require you to contribute more money to reach your income goal.
This rule's logic is admittedly simple and not obviouslywrong, because you might conceivably live on less than 100% of pre-retirement incomeby spending in retirement. Without a job, you may not need to buy business clothes or commute to an office. If you have children, they may support themselves rather than relying on you. If you own a home, you may have paid off your mortgage. Your tax rate may fall because your income is lower and you won’t pay payroll taxes unless you continue working . At the same time, youprobably won’t continue saving for retirement.
Now, consider the possibility of any of the following eventualities. Adult children or other family members may continue to need financial support. Depending upon when you bought your house, years of mortgage payments may lie ahead. Most important, some expenses typically increase in retirement, like health care costs.2 After retiring, you also may spend more on travel or other recreational activities. These are just some of the many reasons there does not appear to be any independent study demonstrating that 70% of pre-retirement income is “enough” for most American retirees.3
Multiples of your annual income.
Some commentators and advisors define “enough” as saving some multiple of your annual income. One source suggests a multiple of 8 to 12.4 Another makes the oddly specific suggestion of an 11.1 multiple, on average, after taking Social Security into account.5 Let’s consider our hypothetical retirement saver couple. These formulas would require savings of between $800,000 to $1.2 million. Again, assuming the couple purchases an annuity with a guaranteed 5% annual return, it would generate $40,000 to $60,000. With Social Security benefits, our retired couple will have an annual pre-tax retirement income of $75,000 to $95,000.
As with the 70% rule, it’s unclear why this amount of retirement income should be enough. In this example, the couple’s retirement income is closer to their pre-retirement income. The implied theory seems to be that if they have lived on $100,000 for a year before retirement, then they should be able to live on 5% to 25% less in retirement. But that result depends upon many of the same contingencies discussed above that might or might not cause the couple’s expenses to decline in retirement. There are no guarantees.
Perhaps most important, families’ incomes can be volatile. Plugging only one year’s income into any formula may not accurately capture how you financed your pre-retirement lifestyle. At a minimum, your retirement planning should rest on a fuller picture of your pre-retirement finances.
A Different and More Detailed Approach
These two rules of thumb don’t provide a satisfying definition of “enough” because they oversimplify your financial life. In particular, they don’t focus on spending. Of course, spending is how you finance your lifestyle both before and after retirement.
Professor Bonnie-Jeanne MacDonald and her co-authors suggested a different, more nuanced, and detailed way to measure whether retirement income will allow retirees to continue their pre-retirement lifestyles.6 It is called the Living Standards Replacement Rate (LSRR). I won’t re-create the LSRR’s detailed mathematical formulas here. Instead, I’ll explain the key principles so you and your financial professional can use them to figure out whether you have enough retirement savings to generate the retirement income you will need.
The LSRR starts with calculating your family’s pre-retirement spending. It assumes your after-tax income during your working years, minus deductions and savings, is the amount you spent. If you do not have lingering credit card debt and/or personal loans, that’s probably correct. The LSRR urges you to include all income, not just your work income — this means investment income, government payments, employer-financed benefits, and gifts, among other things. Then, subtract all non-spending deductions, including taxes, work-related expenses, and payments or gifts to others. Most important, don’t look at only one year. Calculate your average net income over many years, but drop out the high and low outliers.
Finally, take into account how many family members this net income supported in those average years. Professor MacDonald and her co-authors suggest dividing net income by the square root of your number of family members to determine how much each individual has spent. Let’s return to our couple with $100,000 in gross work income. Let’s assume that’s their average pay over many years, but they also received $15,000 in investment income and gifts from family for an annual average of $115,000. Deduct $45,000 of taxes, work-related expenses, and other deductions, and another $11,500 per year in savings. This leaves $58,500 that the couple likely spent per year, on average. If the couple has no children, divide by 1.4 (the square root of 2), and you get $41,785. If the couple has 2 children, divide by 2 (the square root of 4), and you get $29,250.
Now, you have a guideline as to how much our couple must spend in retirement to maintain their pre-retirement lifestyle: either $83,571 or $58,500 — double the individual amount produced by our calculation above. We posited annual Social Security benefits of $35,000; so, with two kids, the couple will need another $23,500 and, if they are childless, they will need another $48,571. This leaves you and your financial advisor to make two final calculations: First, given how tax rules apply to your retirement income, how much pre-tax income will you need in retirement to yield these after-tax amounts for spending? Second, how much savings will generate that level of income every year for the rest of your life? Those calculations will tell you how much in retirement savings is enough for you.
We may not be able to eliminate every worry about retirement; however, you can take steps to know more and worry less. You have the ability and information to calculate how much retirement income you will need to continue your pre-retirement lifestyle when you decide to stop working. It’s not an easy task, but with a small amount of help, you can accomplish it.
The key to calculating a reasonably reliable estimate is to take everything into account: all your income, all your deductions, all your spending, and all the family members your income supports. With a more comprehensive calculus, you can approach retirement with more confidence and less worry.
*What is an annuity?
Annuities are long-term, tax-deferred investments designed for retirement. Variable annuities involve risks and may lose value. Earnings are taxable as ordinary income when distributed and may be subject to a 10% additional tax if withdrawn before age 59½.
Annuities are not for everyone. And, it’s important to remember that these products are meant to be long-term investments designed for retirement, so there are restrictions in place to discourage you from withdrawing all of your money at once or taking withdrawals before age 59½. However, most annuities do allow for exceptions based on specific circumstances such as a terminal illness or other emergencies.
† Guarantees are backed by the claims paying ability of the issuing insurance company.
Investing involves risk including possible loss of principal.
The opinions and forecasts expressed are those of the author and individuals quoted and should not be construed as a recommendation or as complete.
1. "56% of Americans don't know how much they need to retire-here's why that's a problem," Emmie Martin, July 2019
2. "U.S. Personal Health Care Spending By Age and Gender 2014 Highlights," Center for Medicare & Medicaid Services
3. "Measuring Retirement Income Adequacy: Calculating Realistic Income Replacement Rates," Jack VanDerhei, 2006
4. "How much do I need to retire?," Fidelity, July 2020
5. "The Real Deal - 2018 Retirement Income Adequacy Study," AON
6. "How Accurately Does 70% Final Employment Earnings Replacement Measure Retirement Income (In)Adequacy? Introducing the Living Standards Replacement Rate (LSRR)," Bonnie-Jeanne MacDonald, Lars Osberg & Kevin D. Moore, 2016
About the author
Seth D. Harris, Former Acting U.S. Secretary of Labor, Attorney at Seth D. Harris | Law & Policy
Seth D. Harris is a nationally recognized expert in labor, employment and retirement law and policy. He is an attorney in Washington D.C. and a Visiting Professor at Cornell University's Institute for Public Affairs. He also served as Acting U.S. Secretary of Labor for the Clinton Administration, and Deputy U.S. Secretary of Labor from 2009-2014.
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Seth D. Harris is not affiliated with Jackson.