The 10% Lie

We’ve all heard the mantra, save, save, save, to the point that many people have tuned out the message. The scary part is that the message is not aggressive enough. I would argue that the amount that we should be saving is much higher than most experts claim. I’ve heard 10% as a target savings rate and people with 401(k)’s are more or less meeting this target. Current average 401(k) withholding is only 7%. Assuming that the company will contribute 3%, we reach the 10% level being analyzed.

I didn’t reach 10% using a dartboard. For the group of people who think the 10% savings rate is too high or too low, here’s a reference:

"Total contributions—the sum of employee and employer contributions—were higher for participants who received an employer contribution as part of their 401(k) plan than for those who did not. The average total contribution rate was 10 percent of salary for employees in plans offering an employer contribution, compared with 7.4 percent for those in plans not offering an employer contribution." ebri.org

Assume a person makes $1000/year (it could be any number), averages a 3% annual raise and the country averages 3% inflation. That leads to stagnant wages, which is consistent with government reports. Finally their investment portfolio returns 8% annually. Eight percent might seem conservative, but once you factor in a mix of investments and fees I feel it’s a reasonable number.

When computing retirement salary I've excluded the employee portion of the retirement deposit, since you would not be making that in retirement. I've included 100% and 80% "living money" columns to provide some contrast, although I don’t feel that many people will want to retire on less money than they have grown accustomed to.

How much do you need to save and for how long? The detailed answer is in the reference spreadsheet and you should feel free to play with the assumptions.

Here is the summary,

Saving %	Years of Work	% Withdrawal	% Final Salary
10%	41	4%	80%
10%	45	4%	100%
10%	47	3%	80%
10%	51	3%	100%
19%	35	4%	100%

This is obviously a very simple spreadsheet and doesn't attempt to consider variable returns of any type. It doesn’t delve into retirement investments that allow you to preserve your purchasing power. Plus you will probably change jobs at least five times during your working career, which might limit the number of years you are able to contribute to your retirement plan. I also do not discuss Social Security ... yet. Given the current situation I don't think you can accurately project your returns from the system, but you can make conservative estimates.

The most generous assumption gives you a working career of 41 years before you can take a 20% salary cut and retire. That seems like a big cut and a long career to me. The most conservative assumption requires you to work for 51 years before you can retire at full pay.

This means that if I am fresh out of college at 22, faster than I made it btw, I would need to remain employed and able to contribute to my retirement until I'm 63. I know that Social Security says I should retire at 67, but frankly I think they are wrong.

In my opinion the basic retirement plan would be to work for 35 years, which will likely happen at roughly 59 1/2 for many college graduates. To do that without a pay cut would require a 19% savings rate assuming a 4% withdrawal rate. Hopefully you'll get some of the 19% from your employer, but the current 7-10% is about half of what the employee is really going to need.

"Among workers at firms sponsoring 401(k)-type plans in 1983, only 38 percent participated, compared with 70 percent in 2003 (Figure 4)." ici.org

The 30% of people who are eligible to contribute to a 401(k) but do not are beyond the scope of this blog, since I simply can’t understand their thinking. The people who aren’t offered a retirement plan just have to do their best with IRAs, but they have my sympathy.