By Dave Rowan
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When you think about saving for retirement, you likely wonder, “How much of my paycheck should I save each month?”
The answer is complex and depends on many variables, but a popular guideline is the "50-30-20 rule," introduced by U.S. Sen. Elizabeth Warren and her daughter in their book "All Your Worth: The Ultimate Lifetime Money Plan." This rule states that 50% of your money should go toward necessities, 30% should go toward discretionary spending or “nice to haves,” and 20% should go toward savings — such as for retirement — or paying off debt.
Wow, 20%! That’s a big number to carve out of every paycheck for savings. But it appears that many people aren’t following the rule at all. Federal research shows that about half of all American households have no retirement savings whatsoever. The personal-net-worth picture isn’t much better. According to the Census Bureau, the average personal net worth (excluding home equity) for Americans ages 35 to 44 is $14,226, and for those between the ages of 55 and 64, it’s $45,447. These figures do not seem consistent with people regularly saving even 5% of their incomes.
I’m 46 years old and I can tell you that I have definitely not been following the 50-30-20 rule when it comes to my retirement savings plan. My savings followed more of a 50-40-10 rule, with about 10% of my savings going to retirement since I started working in my early 20s. And as I'm a financial advisor, it shouldn’t surprise you that I’ve done the math and feel very good about my long-term finances and ability to retire comfortably, maintaining at least the lifestyle that my family enjoys today.
So after looking at the national averages and my own personal finances, I’m left wondering whether the 50-30-20 rule is overkill and whether I should recommend it to my clients. As usual, when I’m faced with this kind of question, I break out the spreadsheets and start cranking through some numbers.
Do the math
To assess the validity of the 50-30-20 rule, I analyzed the necessary saving rate for five hypothetical retirement savers. I assumed that each began saving for retirement at a different age: 22 (my own experience), 25, 30, 35 and 40.
I also used the following assumptions; your circumstances may differ:
- You started your career in 1992, earning an average salary of $41,000 before taxes. (This was my starting salary as a newly minted chemical engineer, fresh out of college.)
- Inflation and salary increases are assumed to be equal, at 4% per year. (This is a conservative assumption for inflation, higher than it has been recently.)
- You pay a total (federal, state and local) tax rate of 33% of your income throughout your career.
- You want to start your retirement in 2040 with the same standard of living you had in 1992. This requires an after-tax income of $180,492 to account for inflation.
- You work full-time until age 70.
- Your average investment returns are 8% per year, net of all fees and expenses.
- You begin collecting Social Security at age 70 in 2040 with a starting annual benefit of $58,810 per year.
- Your Social Security benefit increases by 2% a year, and you increase your required retirement income by 2% each year between the ages of 70 and 100. (This is a cost-of-living adjustment due to inflation.)
- You live to be age 100.
So what percentage of income did each of these five hypothetical savers need to put away to maintain this standard of living in retirement through age 100? Not surprisingly, the earlier you start, the less you have to save. Here are the results:
START OF RETIREMENT SAVING
REQUIRED % OF INCOME
Calculations by Dave Rowan
Results may vary
I can’t stress enough that the table above is simply meant as a general guideline and may or may not apply to your situation. The assumptions I’ve made are relatively conservative, and many things could make the math better or worse.
For example, you may be able to get by with a lower rate of savings if one or more of the following is true:
- Market returns are higher or inflation is lower.
- You decide to semi-retire at age 70 and continue working part-time beyond that.
- You’re in a lower tax bracket or live in a state with lower taxes.
- You’re willing to accept a reduced standard of living later on during retirement (say ages 85 to 100).
- You don’t live to 100 (it’s hard to root for this one, but it does help the math).
No matter your circumstances, you can take away three main points and build them into your long-term financial plan:
- Start saving for retirement as early as possible.
- Plan on saving a minimum of 10% of your income — even more if you can.
- Put a long-term plan in place to save 20% of your income, particularly if you did not meaningfully start to save for retirement before age 35.
This is my take on the 50-30-20 rule: It could be the right advice for you, but it all depends on when you start saving.
Dave Rowan is a certified financial planner and the founder of Rowan Financial.