A new report by the Center for Retirement Research at Boston College looks into how much individuals must save for a secure retirement, based on earnings, the age they started saving, the age they plan to retire and asset returns.
According to the RETIRE Project at Georgia State University, households earning $50,000 and over need about 80 percent of pre-retirement earnings to maintain the same level of consumption. "Households earning less need a higher percentage because they generally save very little for retirement and pay much less tax while working," the report says.
An average earner who starts saving at 35 and retires at 67 must save 18 percent each year, assuming a 4 percent return on investments, to achieve that percentage of retirement income. The comparable rate for low and high earners was 12 percent and 22 percent, respectively.
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People need less to live on in retirement to maintain their standard of living because they pay less in taxes, the report found. "They no longer pay Social Security and Medicare payroll taxes and they pay lower federal income taxes because—at most—only a portion of their Social Security benefits are taxable," the report says. Once you are retired, you no longer need to save for retirement and most people pay off their mortgages before they retire. One other factor is retirees don't need to spend as much on work-related expenses like clothing and transportation.
The first step in figuring out how much you need to save to achieve that 80 percent replacement rate is to calculate the percent of pre-retirement earnings that Social Security will replace. Subtract that number from the 80 percent figure to determine the percent of earnings that must be replaced by individual savings. The required saving rate will depend on the real return earned on accumulated assets, when the individual began saving and when the individual retires, according to the research.
The final issue is to determine the income drawn from retirement savings. This report assumed a withdrawal rate of 4 percent at age 65.
The report used as an example a person who was 25 years old in 2010 who earns $43,000 a year and retires at age 67 in 2052. "Under current law, Social Security will replace 41 percent of this individual's final inflation-adjusted earnings of $71,000; so the individual has to save enough to replace 39 percent or about $27,700. With the 4 percent rule, the individual needs just under $660,000 in 2052. If the individual starts saving at 35 and earns a real return of 4 percent, he will need to save 18 percent of earnings each year."
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