Are You Saving Too Little or Too Much for Retirement?

by Tom Allen and Mark Hebner - Wednesday, 10 February, 2016

How do we enjoy our resources today without sacrificing future financial security? What is the delicate tradeoff between current and future consumption? These questions are extremely important. At one extreme we find the vast majority of Americans spend almost all of their current earnings for a variety of reasons. Student loan debt, mortgages, supporting a family, and yes, even just flat out spending on “stuff” are all viable reasons for this behavior. In effect, these people are not necessarily worried about future consumption or are so strapped in resources that they have no other choice. At the other extreme, we have the big saver who lives on pennies in order to max out their 401(k) and other retirement accounts. These investors are willing to forgo current satisfaction for a more secure financial future. Most investors find themselves somewhere in the middle.

Who is right? That answer of course is, it depends.

Savings Rates Rules for “The Middle”

Most investors want to have a healthy balance between current and future consumption. They don’t want to be so minimalist in attempt to be financially secure by the age of 40. On the other hand, they don’t want to find themselves having very few resources at retirement. A well-known “rule of thumb” in our industry is the “10% Rule.” Pay yourself 10% of every paycheck you make. This is often too simplistic to work for everyone. Savings rates should be based on a few different variables:

  • Income Replacement: How much of your current income are you going to spend in retirement?
  • Retirement Age: When are you going to retire?
  • Future Path of Earnings: How much will your earnings change over your working life?
  • Risk Capacity: How much risk are you willing to take with your financial capital?

There are no “one-size fits all” solutions based on these variables. Fortunately, researches have already started to dive into these questions in order to provide guidance for investors.

Income Replacement

The goal for most retirees is to be able to carry their lifestyle near or at retirement into retirement. Assuming the absence of a pension plan, the income replacement rate for most investors depends on their income at or near retirement. For those who find themselves in the highest quartile of earners in this country, research has shown that most retirees spend about 60% of their pre-retirement income in retirement. The reason why it is less than 100% is because retirees are no longer saving for retirement, usually pay less in taxes, and major debts (like mortgages and college education for children) are usually paid off. Of the 60% needed in retirement, 20%, on average, comes from Social Security. So this investor needs to aim for about 40% of replacement income coming from personal savings. On the opposite end, for investors in the lowest quartile of earners in this country, their replacement rate is around 80% with Social Security covering roughly 60% of the overall total. The exhibit below gives a visual representation of these relationships.

Nobody knows for sure how much he or she is going to consume in retirement, but working off of averages can be very informative in terms of understanding typical spending behavior by most Americans. The help of a Wealth Advisor can aid investors on establishing a more precise bogey to aim for. Overall, assuming a 40-50% replacement rate is a very conservative estimate about what is needed in retirement.

The Tradeoff

Assuming that most people who retire around their normal retirement age (mid 60s) want to replace 40% of their current standard of living and follow a simple glide path of investing based on a stock allocation of 120-age, as well as, assuming thousands of simulations of income path projections based on the Panel Study on Income Dynamics (PSID) from the University of Michigan, we can start to run simulations about proper savings rates at certain confidence levels [1]. For example, in order to replace 40% of preretirement income with a 95% degree of confidence, an investor will need to save, on average, 16.80% over their entire working life (25 – 65). This is much different than the standard 10% rule. In fact, using a 10% savings rate would give an investor less than a 90% chance of meeting their goal. The table below gives multiple savings rates based on replacement income needs and levels of confidence.

What is also informative is the cost of forgoing current consumption for future consumption. If an investor was able to save 16.8% over their working life for retirement, they would have been 95% confident to meet their 40% replacement rate. The median outcome from running these simulations ended up with an overall replacement rate of 130%. Because we are running simulations with random variables like expected returns, pathway of earnings, etc., we have a distribution of outcomes. For someone who is looking to be very confident about meeting a specific spending goal, the downside is possibly over saving for retirement.

How Do I Know I Am On Track?

Being able to provide feedback in the middle of working years can be very helpful for investors who want to understand this tradeoff. While many investors would be happy to have more than enough resources in retirement, some are very sensitive to passing on the vast majority of their accumulated wealth to heirs versus enjoying their own hard work. Being able to buy that vacation home, taking that trip around the world, or taking risk and starting one’s own company are very real goals for investors.

Fortunately, we can provide some feedback to give clarity to investors who are sensitive to this. Using asset/income multiples, investors can adjust their savings rates accordingly in terms of saving for retirement. For example, for someone who is 45 years old and has 4 times the amount of retirement assets as their current annual income, they may be over saving for their current retirement goal. They could decrease their savings rate by 1% and still be 90% confident of meeting their retirement goal. That 1% can be used elsewhere in that investor’s current consumption. The table below gives guidance based on current age and different asset/income multiples.


Saving for retirement is a delicate tradeoff between current and future consumption. The vast majority of Americans are saving too little to meet their future needs. Although many practitioners may recommend a 10% savings rate, we now know that this rule may not meet the goals for a large amount of investors. Understanding consumption behavior of retirees and historical income paths, we can start to put fences around the required savings rate to meet retirement goals. Being able to provide feedback in terms of asset/income ratios can be helpful for investors who are sensitive to over saving for retirement. With the help of a Wealth Advisor, investors can hone in on what is required for their very specific financial situation. Depending on specific goals, the required spending needs may need to be adjusted.

[1] De Santis, Massi PhD and Marlena Lee PhD. How Much Should I Save For Retirement? Dimensional Fund Advisors, LP. June 2013.