Where will my retirement income come from?

Fidelity believes that retirement savings should generate about 45% of an investor's preretirement, pretax income.

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Have you ever found yourself lost when visiting a new place? Then you know how hard it can be to find something when you don’t know where you are going. The same applies to saving for retirement—we call it your someday. Until you know the goal, it is hard to figure out if you are on the right path.

But even if you don’t have a clue about what your someday will look like, you can start by assuming you will at least want to save enough to maintain your current lifestyle. But how much is enough?

Living your someday the way you want means having a road map now—including what percentage of your income in retirement needs to come from your savings. That’s why we did the analysis and came up with four key metrics: a yearly savings rate, a savings factor, an income replacement rate, and a potentially sustainable withdrawal rate, to help you create your retirement road map. (See chart.)

They are all interconnected, so it is important to keep each in mind as you save for retirement, and understand how they work together. For instance, if you want to retire earlier than age 67, your savings rate and how much you need to save would likely increase. Retire later and they probably can decrease.

We will focus on each guideline in separate Viewpoints articles. (To read about all our retirement guidelines, see the Viewpoints special report: Road to retirement.) Here we focus on the income replacement rate—the percentage of income in retirement that needs to come from savings.

How much is enough?

We did the analysis and concluded that those with between $50,000 and $300,000 in annual income should plan for their savings to replace about 45% of their preretirement, pretax income. For example, consider a hypothetical investor, Joanna. She earns $100,000 when she retires at age 67. She’s saved 10 times (10x) her preretirement income or $1 million for retirement. That $1 million in savings is enough to generate 45% of her preretirement, pretax income, or $45,000. That’s also a 4.5% sustainable withdrawal rate, giving Joanna a high level of confidence that she won’t run out of money, regardless of market performance.

The costs of life in retirement

“The good news is that to maintain your lifestyle in retirement you won’t need to replace your entire paycheck—and the money doesn’t all need to come from your savings,” says Adheesh Sharma, vice president of financial solutions for Fidelity’s Strategic Advisers, Inc.

Fidelity analyzed extensive spending data and found that most people needed to replace between 55% and 80% of their preretirement income after they stopped working to maintain their lifestyle.1 Why the drop? Well, you don’t need to save for retirement once you are retired. And not working generally means lower taxes, less need for life insurance, and lower day-to-day expenses. After all, you don’t need to pay for work clothes or commuting costs. You may also decide to pay off your mortgage.

Where will the money come from? Social Security will cover some of your spending needs—relatively more for lower than upper income people (see graph below). After that, Fidelity research finds that an investor will likely need to replace at least 45% of your pretax paycheck from savings,2 including pensions, although the exact amount will vary depending on your income, retirement age, and other factors.

How much you earn matters

Your salary plays a big role in determining what percentage of your income you will need to replace in retirement. People with higher incomes tend to spend a small portion of their income during their working years, and that means a lower income replacement goal in percentage terms in retirement. As you can see in the chart below, someone who makes $50,000 might expect to need to replace around 80% of his or her income in retirement, while someone who earns $200,000 might aim to replace closer to 60%.

Social Security covers less for higher earners

For most people, a significant portion of retirement income comes from Social Security, but that share is relatively higher for lower-income people. As you can see in the chart above, a person earning $50,000 a year could expect Social Security to replace about 35% of income, or $17,500, while someone who made $200,000 each year might expect to get 16% of that income from Social Security, or $32,000. If you made $300,000, only 11%, or $33,000, would likely come from Social Security.

When you retire matters

The age at which you choose to stop working is another big factor in how much of your preretirement income you will need to replace in retirement. Most people are eligible to receive Social Security benefits as early as age 62, but those benefits increase if you wait until your full retirement age (usually 67), and rise even more if you delay until age 70.

The earlier you retire, the more you will have to rely on savings to meet your income needs, because your Social Security payments will be lower (see chart). Let’s consider Bill, who plans to claim his Social Security benefits as soon as he retires. Bill needs to replace 45% of his income from savings if he retires at age 67. If he stops working at 62, that number would go up to 55%. But it drops to 40% if he stays in the workforce until age 70.

“Delaying retirement gives you more time to save and higher Social Security benefits,” explains Sharma.

The bottom line

Once you know where you are going, it becomes a lot easier to make a plan to get there, and to measure your progress along the way. When it comes to saving for retirement, set a course for maintaining your current lifestyle in retirement—and plan for your savings to provide 45% of your preretirement income.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.
1. Fidelity analyzed the household consumption data for working individuals age 50 to 65 from Consumer Expenditure Survey 2011, U.S. Bureau of Labor Statistics. The average income replacement target of 45% is based on the objective of maintaining a similar lifestyle to before retirement. This target is defined at 35% for ”below average” lifestyle and 55% of preretirement income for ”above average” lifestyle. Therefore, the final income multiplier target of 10x the final income goes down to 8x for ‘below average’ lifestyle and increases to 12x for ‘above average’ lifestyle. See footnote 4 for investment growth assumptions.
2. Assumes a single-income household retiring and claiming Social Security retirement benefits at age 67.
Fidelity has developed a series of income multiplier targets corresponding to different ages, assuming a retirement age of 67, a 15% savings rate, a 1.5% constant real wage growth, a planning age through 93, and an income replacement target of 45% of preretirement income (assumes no pension income). The final income multiplier is calculated to be 10x your preretirement income and assumes a retirement age of 67. The income replacement target is based on Consumer Expenditure Survey 2011 (BLS), Statistics of Income 2011 Tax Stat, IRS 2014 tax brackets and Social Security Benefit Calculators. The 45% income replacement target (excluding Social Security and assuming no pension income) from retirement savings was found to be fairly consistent across a salary range of $50,000-$300,000, therefore this factor may have limited applicability if your income is outside that range. The 45% income replacement target assumes a retirement and Social Security claiming age of 67, which is the full Social Security benefit age for those born in 1960 or later. For an earlier retirement and claiming age, this target goes up due to lower Social Security retirement benefits. Similarly, the target goes down for a later retirement age. For a retirement age of 65, this target is defined as 50% of preretirement annual income, and for a retirement age of 70, this target is defined as 40% of preretirement income. As the income multiplier target is based on income replacement target and retirement age, for an earlier retirement age, this target goes up due to lower social security retirement benefits and a longer retirement horizon. Similarly, the target goes down for a later retirement age. For a retirement age of 65, this target is defined as 12x and for a retirement age of 70, this target is defined as 8x.
Guidance provided by Fidelity through the Planning & Guidance Center is educational in nature, is not individualized, and is not intended to serve as the primary basis for your investment or tax-planning decisions.
IMPORTANT: The projections or other information generated by Fidelity’s Planning & Guidance Center Retirement Analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use and over time.
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