The Definitive Retirement Number

by: Roger Nusbaum

With a hat tip to Chuck Jaffe Fidelity has run the numbers and figured that having eight times your final salary in the bank or brokerage account or 401k is the magic number. And to help benchmark along the way, at age 35 people should have one year's salary set aside, at age 45 it should be three times and at age 55 people should be up to five years salary set aside.

The objective here is to replace 85% of the final income, which as Jaffe notes is up from the "rule of thumb" of replacing 75% of the final income. There were some details missing and no link to the research by Fidelity. There was no mention of a withdrawal rate or whether the 85% includes Social Security benefits. If not then the withdrawal rate would have to be astronomically high.

To use round numbers, let's say the final salary is $100,000 so the target savings balance would be $800,000 with an income objective of $85,000. If they are not including social security then obviously the withdrawal rate would be more than 10%. If it includes social security then the total benefit for a couple might be about $3,000-$3,300 per month in today's dollars so the portfolio would need to come up with $3,783-$4,083 per month which works out to a withdrawal rate of 5.3%-5.7% which is a big bogey. If the money is in an IRA of some sort then there is the additional problem of taxes on the withdrawals. There may be more to it though, though again no link was provided.

Long time readers will know that I believe in taking no more than 4% out annually. If that means ratcheting down the lifestyle then so be it. People want what they want but if that does not fit with reality then something has to give.

Another cornerstone here has been that focus should be paid to the spending part of the equation. People who live below their means don't need to focus on a percentage of their income - they need to focus on their spending needs and whether those needs might go up or down after they retire and then they either have enough or they don't. It is not unreasonable that a moderately well to do couple could have a $60,000 lifestyle, $1 million saved, $10,000 in income from some sort of monetized hobby, $36,000 in combined social security benefits and so only need $14,000 from the portfolio.

If the above couple had saved $600,000 instead of $1 million they would not be placing a heavy burden on the portfolio at $14,000 and might be able to grow the portfolio meaningfully before possibly needing to increase the withdrawal. This would of course rely in some measure on what the market does; it is not realistic to think a portfolio will go up by 40% in five years if the market is flat. It could happen, it just wouldn't be an assumption that people should make.

I would also not give up on the notion of being able to reduce spending in retirement. No financial plan can account for every possible life circumstance but with a little planning it is feasible to have the mortgage paid off upon retirement (or maybe sooner). I found a stray reference that the average mortgage payment is 20% of income. Who knows if that is accurate but if it is, that along with not saving 10% of income anymore would allow for a 30% reduction in expenses before even needing to consider any lifestyle changes.

While we can appreciate the positive aspect of what Fidelity is trying to do with this sort of research (the negative is that it is just an AUM grab), it seems that most people don't start to think about retirement until their 40s or 50s and we know that very few people that age have three, four or five times their annual income socked away. Great for those who do but for those who don't, something will have to give. They will have to live a more modest lifestyle than they envision and do something that creates an income for a little longer than they envision.