Do Fidelity’s Retirement Savings Benchmarks Hold Water?

Susan Dziubinski:

Hi, I'm Susan Dziubinski with Morningstar. Salary-based rules of thumb for estimating retirement savings, such as you should have 8 times your annual salary saved by the time you're 60, are popular with investors. But are they good benchmarks? Joining me today to discuss some new research on the topic is Amy Arnott. Amy is a portfolio strategist with Morningstar.

Hi, Amy, thank you for being here today.

Amy Arnott:

It's great to be here.

Dziubinski:

So let's talk in broad strokes about what these salary-based rules of thumb are trying to achieve. What's good about them?

Arnott:

So as you said, it's a rule of thumb and sort of a quick way to check in and see if you're on track for retirement. It's kind of like a mental shortcut. And the thing that's good about them is they take a concept that can be very abstract--which is: How much do I need for retirement, which might be 20 or 30 years down the road?--and they translate it into something that people can relate to today, which is: How much am I earning right now?

Dziubinski:

And one of the most popular and often cited set of salary-based benchmarks for this comes from Fidelity. What are some of the assumptions that underpin the benchmarks that Fidelity is very well known for?

Arnott:

They assume an annual increase in your salary of 1.5% after inflation, a 15% savings rate each year, retirement at age 67, and a life expectancy of 93.

Dziubinski:

Now you've run some numbers to look at how the numbers might play out in the real world. Based on that exercise, who do these salary-based savings assumptions work best for?

Arnott:

The numbers are based on a pretty steady pattern--small increases in your salary each year and very consistent savings rate over time. So if you're someone who might have more ups and downs in your income, or maybe you weren't able to start saving in your 20s, they might not work quite as well.

Dziubinski:

If you do fall into that cohort, where "Yeah, these targets do work pretty well for me." What does that mean for your retirement income?

Arnott:

I did a year-by-year projection to see what the numbers might look like. And based on the projected value at the end and the target income replacement that Fidelity is using, you end up with about a 4.5% portfolio withdrawal rate, which is a little bit higher than the 4% rule that a lot of people have probably heard of. So if you are looking to plan for a slightly longer retirement, either you want to retire before 67 or you think you might live past 93, you might want to bump up your savings target a little bit more.

Dziubinski:

At the end of the day, Amy, if people are using these salary-based benchmarks--which again, we've said have been pretty good rules of thumb for people to use--what should they keep in mind if they're going to use them?

Arnott:

I think one of the most important things to keep in mind is that these are just guidelines and not to get too discouraged if you find yourself behind any of the targets. In order to stay on track with every single target, you would have to be saving a pretty high amount every single year starting in your mid-20s, which may not be realistic for everyone. But even if you're getting a later start, you do have time to make progress toward catching up, especially in your 40s and 50s can be a good time to start saving more aggressively toward retirement. And after you turn 50, you are able to make catch-up contributions to your 401(k) of up to $6,500 a year. So that's something that can really help you especially if you feel like you are a little bit behind and need to catch up.

Dziubinski:

Amy, thanks so much for taking a deep dive into these. Again, you see these in the media a lot. A lot of people use them. It's really good to have some perspective on how to best think about them. We appreciate your time.

Arnott:

Thanks. Nice talking with you.

Dziubinski:

I'm Susan Dziubinski with Morningstar. Thanks for tuning in.