Your Savings Target

When it comes to saving for retirement during your working years, you need a target—some amount that when you’ve saved it up, you can feel confident in giving up your source of income if that’s what you want to do. How much is enough? Unfortunately, unless you put some thought into this question, the answer will be there’s never enough; you’re doomed to be a wage slave for the rest of your life. To be freed from the bonds of financial slavery, you should have a numerical target in mind.

Coming up with your target is a complicated process, but you can start with a tentative step, and build and hone from there. So here it is, your first step: Start by determining your current annual allowance—now, during your working years. Then make a few adjustments. And then multiply it by a suitable multiplier. And that’s your target. What could be simpler?

First, your allowance. Remember the goal of retirement planning, the principle that you want Future You to live just as comfortably as Present You, no more no less. Your current salary that you live on is a pretty good starting point. It sort of defines your standard of living. An example is helpful. Consider Ernie, who earns $100,000 salary. Present Ernie wants to plan for Future Ernie to live the $100,000 life.

Next some adjustments. Ernie does not live on the full $100,000. There’s two common adjustments that disappear when he retires. The first is Social Security and Medicare tax, which he never gets to spend. And which he will cease paying when he retires. So Ernie can reduce his tentative $100,000 spending goal by 7.65% (the combined FICA tax rate) down to $92,350. The second is retirement saving. Let’s say Ernie contributes 6% of his salary ($6,000) to his employer’s 401(k) plan. So he’s not living on $92,350; he’s living on $86,350. His target is shrinking. It’s looking more attainable.

Then there are some common expense adjustments. Now Ernie pays his mortgage every month. That’s a big component of his living expenses. Ernie checks his statement and realizes his mortgage will have been paid off before his projected retirement date. That’s an expense that will disappear—$24,000 per year in Ernie’s case. (Just the principal and interest; not the escrow for taxes and insurance, which goes on forever.) Ernie’s commuting expenses are another adjustment; in his case $2,400 per year. But expense adjustments can go both ways. Ernie’s employer now pays for his health insurance. While he anticipates Medicare eligibility at age 65, he also anticipates a cost of supplemental insurance at $6,000 per year. After taking these adjustments into account, Ernie’s target has shrunk to $65,950.

But wait! There’s more! Ernie has been paying into the Social Security system which will provide up some of that $65,950. He goes to the Social Security website, and uses the wonderful calculators there to project his annual Social Security benefit, which he finds will be $18,000. If his employer had sponsored a traditional pension plan, he would further adjust for his projected pension benefit, but alas that is not the case. Nonetheless, Ernie’s target has shrunk to $47,950 per year.

Final step, Ernie multiplies that by a suitable multiplier. How much of a multiplier? Is it 25? Or 20? Or 17? That depends on the spending and investment plan he intends to adopt when he gets to his intended retirement age. But that’s a subject for another post. For the sake of discussion, let’s say his multiplier is 17. Then his savings target becomes $815,150.

Now Ernie has a concrete goal. He has a plan! Ernie is very happy.