In this client-ready video, Massi DeSantis, PhD, of Dimensional Fund Advisors, explains that the answer should be customized for each individual, based on how their salary grows prior to retirement. Here are the key takeaways:
1. The number one solution for retirement is to save, but how much to save is a key question.
2. Saving early in one’s career and 10% of one’s income is the rule of thumb.
3. When this 10% rule of thumb was tested, there were circumstances where it worked well and other times when it did not even come close to replacing one’s standard of living.
4. Compare the 10% savings rate for Jack and Jill. They both have a 40-year career, but Jill’s salary is $100,000 for the whole 40-year period. Jack starts at $20,000 per year, but his salary increases. His ending salary is $180,000 in year 40.*
5. The 10% rule of thumb works well for Jill who replaces about 51% of her income withdrawing about $51,000 per year from her 401(k) account.
6. The 10% rule of thumb failed Jack. Replacing only 22% of his income or about $40,000 per year, his savings did not even come close to replacing his standard of living.
7. Jack would benefit from a more dynamic approach where his initial savings rate is 5% but eventually increases to 15% once his salary reaches 100k. So as Jack’s salary rises so should the percentage he saves.
8. Increasing his savings percentage would allow Jack to replace about 41% of his income and receive about $75,000 per year.
9. Savings rates should increase as one’s salary increases.
*Disclosure: The assumed rate of return on investments is the same for Jack and Jill at 4.5% annualized. This rate of return is not guaranteed. Neither scenario includes any income received from Social Security or a pension.