How much should I save to prepare for a comfortable retirement? Most people ask themselves this question at some point in their working life (hopefully, relatively early). With the continued shift toward defined contribution plans, future retirees are being asked to take on more responsibility for their retirement outcomes than in the past. So the question is of vital importance. But do we have a good answer?
First, it is important to note that simple rules of thumb do not work for many people. When planning for retirement, income uncertainty can be substantial, so a one-size-fits-all solution is unlikely to work. In particular, the saving rate that works well on average does not work well for people with steep income trajectories or high income variation over their working life—the very people who may need to rely more on personal savings.
We have found that what works is a tailored solution that incorporates characteristics of each household. Specifically, dynamic approaches that take more information into account will improve retiree success rates. One crucial piece of information is household income. We derive income-based saving rates that work across many income profiles, particularly for high-income, high-variability individuals. As income changes over time, individuals increase their saving rates as income grows, with downward adjustments if income declines. Following this rule, different individuals at different stages of their careers (or different income levels) will have different saving rates.
Saving rates that depend on income levels make sense: Households with high income during their working years have more income that needs to be replaced during retirement. The willingness and ability to save also tend to rise with incomes. A dynamic approach to saving accommodates changing retirement needs and savings capacity.
Article by Dimensional Funds
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