The Math Behind the 15% Recommended Savings Rate

There seems to be a consensus among those in the retirement plan industry that individuals should save 10% to 15% of their salaries in order to have a secure retirement. From where did this suggested savings rate come?

Katie Taylor, vice president of thought leadership at Fidelity in Boston, says the firm used to suggest a 10% savings rate, but after delving more into the numbers, it now suggests a 15% savings rate—including both employee savings and contributions from employers.

Roger Young, senior financial planner at T. Rowe Price in Owings Mills, Maryland, says his firm also suggests a 15% savings rate. “There is mathematical backing to what we suggest,” he says.

According to Young, the 15% suggestion is something T. Rowe Price has analyzed, starting with a model of what amount of income people need to replace in retirement. Its model factors in what individuals are currently spending, what they are likely to spend in retirement, taxes in retirement and the fact that individuals may stop saving once they’ve retired.

“We assume people need to replace 70% of their income in retirement, which could be different based on whether spending habits change. Then we look at how much income Social Security will replace, which could also vary heavily by income and marital status,” Young explains. “We also assume a beginning withdrawal rate of 4% per year. There is a lot of back and forth of opinions on whether this is reasonable, and though it is not a failsafe number, we believe it is reasonable.”

Other assumptions T. Rowe Price makes is that the pre-retirement investment return is 7% before taxes and income grows over time. “We tried not to be too aggressive in our assumption about what people can save early in their career, so our suggestions assume people start to save at age 25, starting with 6% of income and increasing over the years,” Young says.

T. Rowe Price comes to a suggestion of what multiple of income individuals need to have save by a certain age, and what percentage of income they need to save to get to that multiple.

For example, according to a T. Rowe Price Retirement Perspectives article, a 35-year-old would be on track if she’s saved about one year of her income. Most 50-year-olds would be on track if they’ve saved about five times their income. If considering a household, use the older partner’s age and the total income and total retirement savings of the household. The firm’s modeling suggests individuals can get to these numbers by saving 15% of income each year.

Similarly, according to a Fidelity Viewpoints article, after analyzing reams of national spending data, Fidelity concluded that most people will need somewhere between 55% and 80% of their pre-retirement income to maintain their lifestyle in retirement. However, Taylor notes that, realizing Social Security will provide much of that income for many, Fidelity concluded that 45% of that replacement income will come from people’s personal savings.

“Fidelity has done modeling, and in our point of view, a goal of saving 10 times final income is applicable for people who make $50,000 to $250,000 per year, which covers between 85% and 90% of workers based on our market share of participants,” Taylor adds.

The Viewpoints article gives a hypothetical example, “Consider Joanna, age 25, who earns $54,000 a year. We assume her income grows 1.5% a year (after inflation) to about $100,000 by the time she is 67 and ready to retire. To maintain her preretirement lifestyle throughout retirement, we estimate that about $45,000 each year (adjusted for inflation), or 45% of her $100,000 preretirement income, needs to come from her savings. (The remainder would come from Social Security.) Because she takes advantage of her employer’s 5% dollar-for-dollar match on her 401(k) contributions, she needs to save 10% of her income each year, starting with $5,400 this year, which gets her to 15% of her current income.”

Fidelity’s estimate is assuming individuals save for retirement from age 25 to age 67. If people start saving later or have a gap in savings, the 15% annual savings rate will need to be increased to reach the goal. For example, a chart in T. Rowe Price’s Perspectives article shows that if a 40-year-old has not saved any of her income for retirement, she will need to save 22% per year to reach the appropriate income replacement goal.

Is 15% the right savings rate for everyone?

Of course, as with every recommendation, there are caveats.

People who make more than $250,000 at retirement age may need to save more than 15% of income to have the lifestyle they want in retirement, notes Taylor. And, people who make less than $50,000 at retirement age may need to save less, in part because Social Security will replace a higher percentage of their pre-retirement income.

Young agrees that low-earners could save a lower percentage of income; however, he warns, “A low-earner now may not always be a low-earner. As salary goes up so does lifestyle/spending, and a lower savings rate may not work so well.”

Young also points out that the more an individual is saving today, the less they are spending, so this may decrease the multiple of income they need to save. As a simple example, he says someone who is saving 10% of income is keeping 90%, while someone who is saving 20% of income is keeping 80% and therefore spending less. “Spending in retirement is a function of what a person is spending before retirement, which is why someone saving more may need a lower multiple of income replacement,” he explains.

While individuals with incomes in the lower range may have difficulty finding enough money to save, those who are very high earners may have difficulty finding vehicles for their savings, Taylor notes. But, if they’ve maxed out contributions to their employer-sponsored defined contribution (DC) plan, they can look to other tax-advantaged accounts, such as health savings accounts (HSAs).

Young says high-earners should be given more advanced financial advice. “They should sharpen their pencils a bit and not rely on a rule of thumb,” he says.

Although people are different and have different situations, as for the 15% recommended savings rate, Young says, “We don’t want to give people false confidence and want to err on the side that will suggest the right percentage for most people.”