A new analysis from the Employee Benefit Research Institute (EBRI) shows that timing really counts when it comes to successful retirement savings efforts: the earlier a person starts saving, the less they will need to put aside every year.
The research findings aren’t groundbreaking, EBRI admits, but they highlight an important truth in retirement planning—the longer a person waits to start saving, the more they will have to divert each month to catch up. This effect is magnified by the benefits of compounding, which often make long-term savings delays nearly impossible to recover from for real-world savers.
EBRI built its analysis using its Retirement Security Projection Model (RSPM), which calculates the savings amounts “needed at different contribution rates, salary levels, and ages for both genders, for various probabilities that they not run out of money to pay for average expenses plus uninsured health care costs throughout retirement.”
As noted by EBRI, the modeling currently excludes any net home equity or traditional pension income and does not factor in pre-retirement leakages or periods of non-participation. These factors are excluded for simplicity’s sake, EBRI notes.
Jack VanDerhei, EBRI research director and author of the report, says the analysis answers two key questions: “How much do I need to save each year for a ‘successful’ retirement? And how large do I need my account balance to be after saving for several years to be ‘on-track’ for a successful retirement given my future contribution rate?”
VanDerhei feels these questions cannot be answered by the commonly used “replacement rate” planning tool, which uses a percentage of income as an optimal savings goal. That’s because the replacement rate method ignores such critically important risk factors as longevity, he says, as well as post-retirement investment risk and nursing home costs. By contrast, the RSPM model includes those factors in its simulations, he adds.
The EBRI analysis presents the required contribution rates for those starting to save at ages 25, 40, or 55. It also presents the minimum account balances required for those contributing to their plans at 4.5%, 9%, and 15% of salary, and shows how much they should have saved at a particular age threshold to be “on track” for a successful retirement.
For instance, the EBRI analysis finds that for a 25-year-old single male with no previous savings who earns $40,000 a year, with a total contribution rate of 3 percent of his salary until age 65, would result in a 50-50 chance of retirement income adequacy. Saving 6.4% of salary would boost his chances of success to 75%, EBRI says, while women that age would need slightly more along the way because of their longer lifespans.
A 40-year-old male with no previous savings earning $40,000 would need a total contribution rate of 6.5% of salary just to have a 50-50 shot at a financially successful retirement, EBRI says, because he has less time to work and save. But saving 16.5% of salary would produce the 75% chance of success—again highlighting the strong benefits of early saving.
Finally, a 55-year-old male making $40,000 with no previous savings would need a total contribution rate of as much a quarter of his salary to reach the 50-50 chance of a successful retirement, again due to little time left in the workforce.
The full report, “How Much Needs to be Saved For Retirement After Factoring in Post-Retirement Risks: Evidence from the EBRI Retirement Security Projection Model,” is published in the March 2015 EBRI Notes, online at www.ebri.org.