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Have You Done Your Retirement Arithmetic?

Author: Jacob Jackson

When it comes to how much money you will need in retirement, the only number that counts is the number 10. As in 10 times your final salary.

That's the word according to Fidelity Investments – or, more precisely, the amount the investment management firm says you will need to have saved up in order to live well, if you want to retire at age 67.

When planning for retirement, Fidelity suggests using four metrics: an annual savings rate, a savings factor or benchmark, an income replacement rate and a sustainable withdrawal rate. These metrics are interconnected, so a change in one affects the others. Also, within each metric are factors that can affect that metric alone.

Master These 4 Metrics

Annual Savings Rate

Let's say you start saving for retirement no later than age 25 (see Why Save For Retirement In Your 20s? if that sounds sort of young). Fidelity suggests you need to put aside 15% of your salary each year.

This, of course, is only a starting point. If you start saving later in life, the rate needs to be higher. For example, your savings rate if you begin at age 30 would be 18%; 23%, if you wait until you are 35 to begin.

The 15% savings rate is also predicated on you retiring at the age of 67. Obviously, if you want to retire earlier (or later), the rate would likely need adjustment.

Savings Factor

Once you've started saving and investing, the savings factor metric will tell you if you are on track to meet your goals. The goal is:

By age 30: Accumulate the equivalent of your annual income that year

By age 40: Three times that income

By age 55: Seven times

By age 67: When you say sayonara to the working-stiff life,10 times your income

Yes, your savings rate increases as you age. But among the assumptions Fidelity makes is that your income will grow 1.5% per year after inflation and that you will invest more than 50% of your savings in stocks.

You can use the savings factor to adjust your savings rate or account for other factors – such as retirement age – as you progress through your working life.

Income Replacement

Fidelity's numbers are based on about 45% of your retirement income being generated by your invested savings. The rest would come from Social Security or other s, such as a company pension.

This percentage is also based on an annual income range of between $50,000 and $300,000. If your annual income falls outside that range, there's a chance the numbers won't add up, although the basic philosophy behind the metrics would likely still apply.

Sustainable Withdrawal

Creating a nest egg of any amount would be futile if, despite your best efforts, you outlive your savings. So, how much will you have to live on, once you actually retire?

Fidelity says that if you follow the metrics faithfully, making appropriate adjustments for income variances, retirement age and other factors, you should be able to withdraw between 4.5% and 5% of your nest egg annually with a high degree of confidence it will last 20 to 30 years during retirement. So if you retired with $1 million in your account, you might withdraw 4.5%, or $45,000 of it, in your first year.

Catching Up

As noted earlier, Fidelity's calculations are based on your retirement plan starting by age 25. If you're already beyond that point, don't panic. Many U.S. workers find themselves behind schedule when it comes to saving (see 10 Signs You Are Not OK To Retire).

Among the suggestions for making up lost ground is making catch-up contributions to any 401(k) or IRA accounts you have, being sure to take advantage (with the former) of any matching employer contributions along the way. If you haven't got an IRA yet, open one: It'll save you money now (tax deduction on your deposit) and earn you more later (tax-deferred growth on earnings). Or, if you qualify, open a Roth IRA (no tax deduction now, but tax-free withdrawals later). Roth vs. Traditional IRA: Which is Right for You? can help you decide.

Reducing or restructuring debt (see When Are You Too Old For A Mortgage?) and trimming your budget can also free up more retirement income. Along with saving more, you could also try earning more: taking on part-time work, for example. 6 Late-Stage Retirement Catch-Up Tactics offers additional ideas.

The Bottom Line

Fidelity isn't the only mathematical voice in the retirement-savings wilderness.

For example, U.S. News and World Report offers slightly different rules of thumb that call for stashing away six months' worth of income in an emergency savings account, in addition to the funds you put away for your retirement years. The publication also suggests that the percentage of your portfolio that is invested in bonds should equal your current age. Obviously, that percentage increases as you get older, dovetailing with the conventional wisdom that assets should shift in orientation from capital appreciation to income-producing as a person ages.

These guidelines can sound strict, even scary. But one advantage to thinking about retirement savings by the numbers is that you soon realize the numbers either add up or they don't. If they do, congratulations. If they don't, then get out your eraser, recalculate – and maybe rethink your life. Or at least, your lifestyle.

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