Is Saving 10% of Your Income for Retirement Really Enough?

There's a reason we're all told, repeatedly, to save for retirement during our working years. Though Social Security does serve as a key source of income for countless seniors, it's not nearly enough to cover the typical retiree's living costs entirely. And since pensions are rapidly becoming a thing of the past, it's up to us, as individuals, to take savings matters into our own hands.

In fact, you'll often hear financial experts tell you to sock away 10% of each paycheck for the future. And that can certainly do a lot for your long-term savings. But seeing as how retirement is often a costlier prospect than most people imagine, it begs the question: Is saving 10% of your income really enough, or do you need to up the ante?

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How far will a 10% savings rate get you?

To get a sense of whether saving 10% of your income consistently will suffice in covering the bills, we'll need to see what sort of numbers we're talking about. The average annual salary in the U.S. is currently about $56,000, so if we take 10% of that figure, we arrive at a yearly savings of $5,600, or a monthly savings of $466.

Now let's talk return on investment. A stock-heavy portfolio is likely to yield a 7% or 8% average yearly return, while a less aggressive portfolio might only yield 5% or 6% -- or possibly less. The following table shows what a monthly contribution of $466 might amount to after 30 years based on your investments' performance:

TABLE BY AUTHOR. *ASSUMES $466 MONTHLY INVESTMENT.

You can't help but notice the difference between an 8% return and a 4% return. While a $633,000 nest egg might very well allow you to pay the bills in retirement, especially when coupled with Social Security, a $313,000 nest egg will offer a lot less buying power.

Another thing to keep in mind is that the above calculations assume a 30-year investment window. But what if you don't start saving right away?

Say you begin saving 10% of a $56,000 salary at age 45, and that you continue doing so for 20 years. Let's also assume that your salary goes up 3% each year, and that you increase your contributions to stay at that 10% target. Even if your investments yield an average annual 8% return, by the time you turn 65, you'll still only have $332,000 for retirement, because your savings window will only be two decades long. And if your investments yield a 4% return on average, you'll be left with just $220,000.

How much retirement income will you need?

Any of these figures might seem like respectable targets at first glance. But when you consider the costs you'll face as a senior, they may not hold up quite as well.

Let's start with healthcare, the one expense that almost universally goes up for seniors. Recent projections tell us that the average healthy couple will spend $377,000 on medical costs in retirement. If we take that figure, divide it in two, and apply it to a 25-year retirement, we're looking at $7,540 a year, or $628 a month, per individual.

Now let's talk about housing. Even if your mortgage is paid off in time for retirement (which isn't the case for a good 30% of seniors), you'll still spend an average of 1% to 4% of your property's value on annual maintenance. Since, at that point, your home will have aged along with you, you'll probably be looking at the top of that range. If we apply the median U.S. home value, which, according to Zillow, is currently $193,800, we're looking at about $7,750 a year, or $646 a month, in maintenance. Throw in property taxes and insurance, which cost Americans $256 a month on average, and you're looking at $902 on housing, assuming there's no mortgage payment involved.

Finally, let's think about the remaining expenses you might face. The average retiree spends $571 a month on transportation and $459 a month on food. That's another $1,030 a month right there. When we add up all of the aforementioned costs, we arrive at a total of $2,560, and that doesn't account for things like heat, electricity, water, cable, phone service, and entertainment. If we estimate these costs at a conservative $500 per month, we're looking at $3,060 per month in total.

Now the average Social Security recipient gets $1,360 a month in benefits, so when we subtract that figure, we see that the typical senior is on the hook for $1,700 a month in expenses. Going back to the numbers we crunched earlier, saving 10% of your paycheck for 30 years at an average annual 4% return gives you $313,000 to work with. When we divide that by 25 years, we get $12,520 a year, or $1,043 a month, in income. In other words, we come up short.

The same thing happens when we take the $332,000 figure that resulted from a 10% savings rate over 20 years at an average annual 8% return. A $332,000 nest egg allows for $1,106 a month in withdrawals over a 25-year period, which also isn't close to the $1,700 we're aiming for.

On the other hand, things shake out quite differently if we apply the $633,000 we arrived at by saving 10% of an average salary over 30 years at an 8% return. Over a 25-year retirement, that figure gives us $2,110 a month in income, which is more than enough to cover the aforementioned estimated costs.

The bottom line

Here's what all of these numbers ultimately tell us: You might come out just fine by saving 10% of your income if you start early enough and choose the right investments. But if you delay your savings efforts or stick to conservative investments, a 10% savings rate might cause you to fall short.

You'll therefore need to adjust that 10% target to accommodate your savings window and investment style. If you're starting late (say, in your mid-40s or after), you'll probably need to sock away 15% of your income or more to catch up. Similarly, if you're going to limit yourself to conservative investments, you'll need to save more to compensate.

Saving 10% of your salary for retirement is indeed a good benchmark to follow. Just be ready to tweak that figure depending on your personal needs and circumstances.