By Dr. Jim Dahle, WCI Founder
A safe withdrawal rate is the percentage that you can withdraw from your portfolio each year in retirement, adjusted for inflation, at which you shouldn't run out of money before dying. But how much of your income do you need to save for retirement?
Wade Pfau, a finance professor, published a paper in 2011 in which he discussed the concept of a safe savings rate.
How Much Do I Need to Save for Retirement?
Many years ago, a WCI reader posted a comment asking how much he needed to save each year in the accumulation stage of his life. Although the answer I am tempted to give is “as much as you can” (which is probably accurate from a behavioral perspective), the answer, from an academic and theoretical perspective, is that “it depends.” But Pfau's paper nails it down about as well as one can.
The real meat of the paper is Table 1, which I've reproduced here.
Let's look at the two extremes to get an idea of what the table is saying. First, if you work and save for 20 years and then want to live in retirement for 40 years on 70% of the salary you were making when you were working—and you're only willing to use a portfolio that is 40% stocks—you need to save 66% of your income each year. On the other hand, if you're willing to work for 40 years, have a retirement of 20 years, live off 50% of your final salary, and use an 80/20 portfolio, then you only need to save 6.3% of your salary.
There's obviously a big difference between 6% and 66%. Most of us are probably somewhere in the middle. A more reasonable assumption is 30 years working, 30 years retired, living off 50% of your final salary in retirement (remember you no longer have to pay as much in taxes or save for retirement and you'll likely get something from Social Security), and use a more standard 60/40 portfolio. This reveals that you need a savings rate of 17% (of your gross income).
More information here:
A High Savings Rate Covers a Multitude of Sins
How to Start Saving for Retirement
My Safe Savings Rate Recommendation
This is the basis for my usual recommendation to save 15%-20% of your income. Ten percent probably isn't enough, and 25%-30% is for those who want to retire early. If you want to retire really early (before age 50), you'd better be pretty darn thrifty before and after retirement. Even with only living off 50% of your salary (remember Social Security won't kick in for a decade or more after you retire) and investing aggressively, you'll still need to save over 1/3 of your income during your working years.
The Importance of Increasing Your Savings Rate
For a “young” investor (meaning one who has a low account balance relative to the amount that person will need to retire—say a ratio of 25% or less), their savings rate has a much greater effect on the amount of money they will have to spend in retirement than their return. Rather than focusing on how to eke out a few more percentage points of return, they would be much better off focusing on increasing their savings rate.
Here's an example:
An investor with $10,000 who saves $5,000 a year expects to have $167,000 15 years from now if they pull off an 8% per year return. If they can increase that return by 1%, they would have a total of $182,000. If they could increase their savings by just $2,000 per year, they would end up with $222,000. They would get much more “bang for the buck” by saving more rather than trying to get a higher return.
The opposite is true for a “mature investor” (defined as someone with a high percentage of what they would need to retire on). Let's say we have a 60-year-old investor with five more years until retirement. They have a nest egg of $1 million. They are currently saving $20,000 per year and expect an 8% return from their portfolio. This will only get them to $1.59 million. Where is the bang for their buck now? If they saved another $5,000 per year, they would end up with $1.62 million. But if they could increase their return by 1%, they would end up with $1.66 million. Clearly, the bang for their buck is in maintaining/increasing their return.
More information here:
Saving for Your Future Stranger
Here’s How Much We Make, Save, and Spend as ‘Moderate Earners’
How to Increase Your Savings Rate
The following are some steps you can take to increase your savings rate.
Increase the Amount of Money You Make
It is much easier to save 25% of $200,000 than it is to save 10% of 40,000, even while paying a higher tax rate. This can be accomplished by further schooling/training to upgrade your skills, changing jobs when opportunities to make more money arise, and taking additional jobs and working overtime.
Save Your Raises
Cost of living and standard raises are frequent with many jobs. Although we often need to gradually increase our spending to maintain our lifestyles, oftentimes we do not need to increase our spending as much as our income has increased.
Keep Fixed Expenses Low
The less you are obligated to spend, the more you have the option to save. Then, you can make conscious decisions between spending and saving each month. Avoid contracts you can’t get out of if your finances turn sour—such as cable, cell phone, boat payments, large mortgages, etc. Try to rent your lifestyle when possible rather than buy it.
Limit the Cost of Your House and Cars
Most people calculate their mortgage payment when they opt for a bigger, nicer house, but they forget that they also have to pay more in taxes, utilities, repairs, landscaping, furnishings, and upgrades. Because your house is a big-ticket item, saving 25% on that will free up much more cash flow than eating out 25% less. To make it worse, most of these expenses are fixed expenses.
Likewise with cars, a great deal of money is lost buying and financing these depreciating assets. The older you buy a car, the less you will pay in financing costs, depreciation, insurance, and sometimes even repairs because you may be less likely to repair unimportant features of an old car, like dings in the bumper or a power mirror that works poorly. The savings in repairs and gas of a new car do not come anywhere close to overcoming these costs.
Watch Out for the Latte Factor
Even small costs can add up over time, especially when considered in light of decades of compounding. The classic example is the $5 latte. If you save that $5 a day ($180 a month, $1,825 a year) and earn 8% per year on it, it will be equal to $482,000 in 40 years. Consciously decide what you want to spend your money on, and spend it on that which brings you the most happiness. Save the rest.
Calculate your savings rate each year. Studies show that we consciously and subconsciously strive to improve in those aspects which we measure.
What percentage of your income are you saving? Has it gone up or down as you get closer to retirement?
[This updated post was originally published in 2011.]
Hi WCI,
I am having difficulty achieving “critical mass”. I graduated fellowship in 2010, work as a cardiologist in the metro NYC area and have tried to follow the guidelines here and at bogleheads but don’t feel like I’m making a lot of progress.
The first two years after fellowship, I was not able to save much after paying off debts and we also had a child. In years 2012 and 2013, I was able to save about 23% of my income both years. But I feel like I am undersaving since my income last year was $368K and my savings percentage should have been higher.
This year, I am fortunate that my income will be about $450K (and it will not rise more than that in the future) but my savings percentage rate will still be around 23-24%.
(I am saving part of the increase in income but part of it also goes to the mortgage which almost increased my housing costs by 50%).
In terms of pure percentages, this is how I break down my spending roughly:
22-24% (savings which means 403B 457B and taxable)
32-35% (taxes, Fed, state NY, medicare, SS)
16% (housing this part included property taxes)
As you can see, this gets me to 70-75% and we live on the rest. We spend about $3500-4000 on food, utilities, personal items and try to live within our means (joined costco, etc.) and spend another $1000/ month on auto (one vehicle is leased, other is an 11 year old car given to me by my father with 70K miles on it). There is also costs for tolls and gas.
I’m not sure what we are doing wrong. The biggest slice in the pie above obviously is taxes and I do have a CPA. But not sure what else I can do except contribute to 403B 457B, pay mortgage interest.
If you have any suggestions, I’d appreciate it. Thanks.
jsong23
That’s a lot of tax, be sure you’re not overpaying. Also consider leaving NY? You’re telling me you’re spending 16%*$450K=$72K a year on housing. Add in the NY specific taxes and I can see why it would be hard to get ahead.
The good news is that you’re saving enough, and perhaps even a little more than you need. But I’d be learning everything I could about reducing my taxes if I was paying over 30% of my gross in tax. On similar income I’m probably only going to pay 22-23% this year. It was 21% last year on lower income.
Hey WCI,
1. Regarding the housing, we purchased a home last year for 950K last year (this is a 2700 sq foot home, 3 beds, vinyl siding, small lot) and the loan amount was for 700K for 15y at 3.25%. The monthly mortgage payments are about $4900 plus property taxes comes out to about $5600/ month. If I add utilities, etc it comes close to $6000/month or 72K/year (16% of my total income). It’s just the cost of housing around the NYC metro area and currently I cannot move due to family reasons.
2. Regarding the taxes, I’ve run the numbers using paycheck calculator and taxcaster apps. I will be paying roughly Fed 110K, State: 25K, Medicare: 6K, SS: 7K for a total of about $148K which comes out to about 33% of my total salary.
Now this is based on a taxable income of $415K (450 – 35K for 403/457 contributions). I did not do personal deductions (not sure about the phase-outs) or the mortgage interest deductions yet and I’m sure those will decrease it a little. I also live in NJ but work in NY and pay state income taxes in NY so that complicates it a little. But I will contribute to a NY 529 to get the NYS income tax deduction.
I really don’t have anything else I can do as far as I can tell. I would love to do an HSA but it is not available. Thanks.
The bad news is that’s a terrible tax situation you probably can’t do much about. The good news is that even after paying those taxes and housing costs, you’ve still got $200K of income to spend/save. With a 20% savings rate, that’s still about $10K a month left over. That’s a pretty nice life.
Jason,
You don’t want to move for “family reasons” but your situation would make me reconsider. You are paying in monthly housing expenses what my family pays for an entire year. You bought a 3br home for $1M…that is just crazy. For a cardiologist, I think you are being underpaid. Congrats on saving 20% but if you are looking to get ahead, look to greener pastures.
This is it! I have always wondered where that 15-20% savings rate came from and how often you say “definitely not 5%” is going to cut it. Thanks so much for making this very sensible.
A couple of grammatical errors:
1st paragraph “… how much he needed to safe each year”
Last paragraph “… more after your retire”
Thanks, fixed.
I believe you have addressed this elsewhere but if we are paying down our student loans (refinanced and paying down at an accelerated rate) do you consider this as part of our “savings rate?”
Not really. That’s something you need to do in addition to saving for retirement. It can all be done at once (save 20% for retirement, save for college PLUS pay down debt rapidly) but only if you control your lifestyle by living somewhat similar to how you did as a resident until the debt is gone. Student loans aren’t like your mother-in-law, where you move her into the basement and keep her around for a few decades. Kick them out of your life as soon as you can and before you get used to all that money.
WCI,
Great posting on the background of a safe savings rate.
Could you help me with the math on the savings rate?
How do you determine your savings rate? I had been calculating mine by simply adding my cash savings, 403b contributions, HSA contributions, and Backdoor Roth savings and dividing them by my gross salary.
Then I read on MMM how he calculates his savings rate using his gross salary plus 401a contributions minus taxes and insurance.
Thank you for any guidance and for your service.
Also, do you include your principal mortgage payments into your savings rate?
No, I probably wouldn’t count those. You can if you want since the only person you’re comparing against is yourself, but since you have to pay for housing one way or another, I wouldn’t.
MMM has a 401(a)? That’s interesting.
But no, I use gross income, not net. You can use either. For instance, I saved 42% of gross last year, but 62% of net. Really the same dollar figure.
How do you account for purchasing a practice? Do you still use 15-20% of gross even with your practice payments? Thanks.
My rule of thumb is 20% of gross to retirement for attendings. Are there times where it might make sense to put your money elsewhere to meet shorter term goals? Sure. I’m thinking things like paying off student loans, saving up a home down payment, or buying a practice. But I find if people really live like a resident for 2-5 years after training, they can meet those goals AND still put 20% toward retirement.
Luckily for many, 20% of gross income is significant greater than the summation of the limits for various retirement accounts ($55,000 + $3,450 + $5,500 = $63,950). So for someone without children, or a spouse, any salary over $320,000 would be that you can’t meet the 20% goal through retirement accounts. If our 403b does not allow for after-tax contributions, this number may be even lower and no where near the 20% of gross income. Are you making up the difference with taxable investment accounts?
Not necessarily, you’re ignoring cash balance plans. But yes, if the sum of your retirement accounts is less than 20% of gross, the rest needs to go into a taxable investing account.
That’s an interesting table. Two thoughts: 1) Most people have variable income in their accumulation stage, so thinking about this as fixed percentage obscures a fair amount. 2) Most people will expect their post-retirement income to relate to their recent pre-retirement income, so if you retire at 65 your expectations are more tied to your lifestyle at 60 than at 25.
Anyway over my 15 years post college, I’ve seen my income veer from negative (graduate school) to high (recently). Unfortunately, savings from my high income years has much less time to compound than the meager savings I had before graduate school. I’d be curious to see an analysis of lifetime investments as a percentage of lifetime income, adjusted for time. So if fictional me saved 20% of my gross lifetime earnings in the first 5 years of my working life, I would have way more money at retirement than if I saved 40% of my gross lifetime earnings in the last 5 years of my working life.
I figure I am going to have to save more than 33% of my gross lifetime earnings to have the results Pfau forecasts because I am playing catch up.
These models are fun to think about, but I am where I am and can only control my savings rate for today.
Hi Jim,
I was hoping you could comment if your savings rate % are based on gross pay or post-tax?
The 20% that is my rule of thumb is gross. I think Pfau’s paper also used gross.
How does employer match in retirement account factor into this number? Or is that ignored for this purposes and you recommend saving 20% plus whatever employer match one gets?
I count the match in both the numerator and the denominator.
Why do you include employer contributions in the denominator? I could see it in a self-employed or partnership situation, where it would otherwise be paid to the owner/partner, but not so much in a W-2, employed situation. Interested in hearing your additional thoughts.
I think it belongs in both the denominator and the numerator. It’s part of your pay, so it belongs in the denominator, and it’s part of your savings, so it belongs in the in the numerator. Presumably if the employer wasn’t putting it in your retirement account it could pay that money to you as cash. Same cost to the employer.
I was not expecting that answer, but I may have to go redo my math but probably won’t change the % a ton. I always assumed because it wasn’t money I was actually ever seeing It didn’t count in the denominator, but I guess you could argue the same thing is true for anything you put into retirement since it never shows up in your bank account. Kinda makes my logic to not count it in the denominator faulty.
Do you and other work covered expenses to the denominator like if they cover your healthcare premiums ? For most people that probably doesn’t make a huge difference, but I was curious.
My Pay is variable and generally it’s in the low 500 K range. 403b, Roth (plus spouse), and mega back door Roth get me to a savings rate of 16-17%. I counted on the employer match to get me up to 20%.
Sorry for the typos. Writing on my phone and I couldn’t go back to edit
I haven’t bothered but it does sound academically correct.
I understand the 20% is a rule of thumb. Could I please clarify what you feel is considered part of the 20%. Do you feel it’s strictly money I put towards retirement? Or should I count the money my employer matches and the amount I’m required to put in my pension?
So if I make $400,000 gross, I generally should save $80k/yr. The $80k can be a combo of my contributions to my 401k, pension, IRA, taxable investments earmarked for retirement and match $? Or should I not count anything but my contributions to my 401k, IRA and taxable investments?
Thank you for the excellent content you and your team make!
For the past five years, my wife and I have maintained an average savings rate of around 55%. It’s been incredible to watch our high savings rate supercharge our portfolio, proving to us that disciplined saving really does pay off.
Now, at 48 (me) and 44 (my wife), we’re well on track to meet our financial goals, especially when it comes to retirement. But here’s the next exciting chapter: in the next couple of years, we’re planning to dial back the savings rate and crank up the fun. After all, what’s the point of building a solid financial future if we don’t enjoy a little more of the present? Time to swap out some spreadsheets for some splurges!
Really solid explanation of the safe savings rate—thanks for breaking it down so clearly! I liked how you tied it to both lifestyle and long-term goals; it’s a great perspective. How do you adjust the rate if income fluctuates a lot, like with bonuses or side gigs? Appreciate the insights!
Not sure there’s a perfect answer to that. You save what you can when you can.
Another classic concept that I feel should be highlighted more, especially to residents, fellows, and maybe even medical students!
I would say a caveat to what you wrote about “the latte factor” is that it’s probably worth fooling with in training and at the very start of your career. That’s when the little frivolities make up a larger % of your income and the opportunity cost compounds due to time.
As a mid/late career attending with a 35-40% gross savings, I can tell you the “latte factor” type of expenses are not holding us back from our financial goals. We don’t even pay attention to them at this stage of life.
Regards,
Psy-FI MD