The Savings Rate Method of Retirement Planning

When it comes to saving for retirement, one of the toughest parts is determining how much to save. Plenty of online calculators allow savers to set goals, and professional financial planners have their own methods for determining target numbers for clients. These options for calculating your retirement number are helpful. But there’s one hitch: They often depend on your best guesses about events that are far in the future.

[See: How to Save $1 Million by Retirement.]

Many aspects of retirement planning require an educated guess. For instance:

— How much will you spend each year of retirement?

— How many years do you expect to live?

— At what age do you plan to retire?

— Will you pay off your home during retirement?

— Will you live in your current location or somewhere cheaper or more expensive?

— How will the market perform, on average, over the next two decades?

Some of these questions are impossible to answer, and your responses might also change over time. But you don’t need to know the answers to all of these questions to build a nest egg for the future.

[Read: How to Get a Good 401(k) Match.]

Select a savings rate. Instead of focusing on a far-away goal of saving $1 million or more by your desired retirement age, you can set monthly or annual savings goals. It’s possible to cut through the complications of your retirement goals by focusing on your current savings rate. Here’s how this savings strategy works:

1. Make concrete savings goals. It’s no secret that Americans have trouble saving for retirement. Some of the problem is likely that retirement seems so far away. Sure, you want to save a million dollars, but it’s easy to delay saving when you have 30 or 40 years until retirement. Focusing on saving a set percentage of your income each year forces you to think in immediate terms.

2. Lower the bar. One way to calculate future retirement needs is by estimating your retirement expenses and multiplying your annual expenses by the number of years you expect to be retired. But it’s tough to estimate your expenses 30 years into the future. Setting a savings rate goal of at least 10 percent of your salary — but preferably 20 percent or more — teaches you to live on less money right now, and you can continue that frugal lifestyle in retirement.

3. Save more quickly. If you look at a retirement calculator with standard inputs, such as average rate of return and annual income, you might find that you can get away with saving less than 10 percent per year. By setting the bar high with a savings rate goal, you’ll save a large balance more quickly, so you’ll reach your savings goal much sooner.

[Read: How Long Does it Take to Vest in a 401(k) Plan?]

Don’t only use this method. The savings rate method is an excellent option for young savers. The younger you are, the more difficult it is to determine what your financial needs will be in retirement. So instead of estimating retirement expenses that could change, focus on saving at least 10 percent of your income, preferably more.

As you get closer to retirement, then you may want to use more complex methods to set your retirement savings target. You may find that you want to increase your savings rate to allow for a more luxurious retirement. Or maybe you’ll find you’re on track to retire sooner than you planned.

The savings rate method is a great way to begin to save for retirement. Then as you move closer to retirement, you can use more complicated methods to refine your retirement savings needs.


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