Financial services giant Fidelity has a rule for retirement savings you may have heard of:
Have 10 times your annual salary saved for retirement by age 67.
This oft-cited guideline can help you identify a retirement savings goal, but it doesn’t fully account for how much of those savings will cover in retirement.
Enter Fidelity’s 45% rule, which states that your retirement savings should generate about 45% of your pretax/pre-retirement income each year, with Social Security benefits covering the rest of your spending needs.
Fidelity analyzed spending data for working people between 50 and 65 years old and found that most retirees need to replace between 55% and 80% of their pre-retirement income in order to preserve their current lifestyle.
Because retirees have lower day-to-day expenses and don’t typically contribute to retirement accounts, their income requirements are lower than people who are still working.
As a result, a retiree who was earning $100,000 a year would need between $55,000 and $80,000 per year in Social Security benefits and savings withdrawals (including pension benefits) to continue their current lifestyle.
Following this Fidelity 45% rule, the same retiree who was earning $100,000 per year would need enough saved up to spend $45,000 a year in addition to his Social Security benefits, to fund his lifestyle.
Assuming the person lives another 25 years after reaching retirement age, this person would need $1 million in savings if the savings generated a 3% rate of return annually in a tax-deferred savings plan (like an Individual Retirement Account (IRA)) and if they were in the 25% income tax bracket.
If you could generate a 5.5% return on your accumulated assets for 25 years in retirement, you’d only need to accumulate $796,033 prior to retirement.
Vanguard (a popular mutual fund company) did a study and the average savings of most people at age 65 is $280,000.*
Guaranteed income for life—if you are interested in a product that has a guaranteed income payment of 5-6%* on the accumulated value every year for as long as you live, please email me at john@assetprotectionsociety.org and I’d be happy to get you information on this product.
Pre-Retirement Income Plays an Important Role
Among retirement rules of thumb, saving 10 times your salary by age 67 reigns supreme. But workers should also have another way by planning for their savings to provide 45% of their pretax, preretirement income.
All retirement spending plans are NOT equal. Those who earned less money during their careers will have less saved than high earners, and as a result, will need to replace a larger proportion of their pre-retirement income.
“Your salary plays a big role in determining what percentage of your income you will need to replace in retirement,” Fidelity wrote in a recent Viewpoints article. “People with higher incomes tend to spend a small portion of their income during their working years, and that means a lower income replacement goal in percentage terms to maintain their lifestyle in retirement.”
According to Fidelity, a person who makes $50,000 per year would need savings and Social Security to replace approximately 80% of his income in retirement. An individual earning $200,000, however, could get by in retirement by replacing just 60%.
Social Security plays a less significant role in the retirement plans of higher-earning workers. Consider the following when using Fidelity’s 45% Rule:
Percentage of income coming from Social Security:
$50,000 = 35%
$100,000 = 27%
$200,000 = 16%
Total Income Replacement Rate (amount of income needed to be replaced):
$50,000 = 80%
$100,000 = 72%
$200,000 = 60%
According to Fidelity, a retiree who made $50,000 per year would receive 35% of that income via Social Security. But a high-earning individual who made $200,000 per year would only see 16% of his income replaced by Social Security benefits. While higher-earning individuals don’t need to replace as much of their pre-retirement income, retirement savings play a more important role for these types of retirees.
Problem with the 45% rule—the biggest problem with the 45% rule is that it’s based on an assumption about when you are going to die.
That’s the problem with the advice given by many financial planners. They typically assume a 25–30-year life expectancy after retirement.
But a good portion of people will live longer. For them, how will the 45% rule work out? Not so well because they will run out of non-Social Security income (their assets will be depleted).
That’s why using a guaranteed income for life* product can play an integral part in a financial plan. Such a product will pay you for as long as you live. So, if you live to 90, 95, or even 100+, it will keep paying.
Bottom Line—Fidelity’s 10x rule of thumb is a nice guideline to follow as you save for retirement over the course of many decades. But saving for retirement is a fluid process that needs to be evaluated annually to make sure you are hitting your marks. If not, you can either try to save more or mentally prepare to work a little longer or live on a little less in retirement.
*Any guarantees mentioned are backed by the financial strength and claims-paying ability of the issuing insurance company and may be subject to caps, restrictions, fees, and surrender charges as described in the annuity contract.
**Vanguard “How America Saves 2022” Data.
