When we’re saving for our retirement the last thing we want is to get to age 50 and realize we’ve been behind for decades!

It’s very useful to know if we are “on track” or if we need to start seriously reevaluating our current lifestyle and future goals.

The internet is filled with retirement calculators, as well as “X-factors” or “multipliers”. In other words, if you have “X times” your present salary at a given age you are on track. If I make 80K a year and my factor is 4X, then I should have 320K saved so far.

Two of my favorite financial institutions, both experts on this sort of thing, have generated their own frameworks. Check them out below:

• Fidelity: “How much do I need to retire?”
• Charles Schwab: “Are you on track for retirement?”

(Disclaimer: I have accounts at both—they are my favorites after all—but no affiliation.)

According to Fidelity, if you’re 45, you need 4X your salary at present. According to Charles Schwab, at the same age, you need anywhere from 7.3 – 11.6X!

What gives?

I dove into the fine print. (Lots and lots of tiny grey font…)

Assumptions listed are provided in the fine print from either Fidelity or Charles Schwab. Some assumptions are not available [?]. *4.5% withdrawal rate calculated based on other assumptions.

How much are you withdrawing your first year of retirement?

The biggest difference between the two models is the number you apply your multiplier to. For Fidelity, you apply your current salary, which is an amount you should be familiar with.

In contrast, Charles Schwab applies their multiplier to your first-year retirement withdrawal amount. This is the more accurate value but will take you a minute to calculate.

• Based on your planned retirement lifestyle, how much of your current salary will you need in retirement?

Some expenses will go away, but some may stay the same. If you are saving a lot now, obviously that piece will not be needed. Payroll taxes or self-employment taxes will go away. If you pay off your mortgage, that will also be a huge saving.

But if you anticipate more travel or more medical expenses, it could be more. You may need anywhere from 80% – 120% of your current salary during retirement.

Second question:

• How much of your yearly expenses will be covered by social security?

If you are one of the lucky few that still has a pension, add that in here too.

Photo by Christian Holzinger on Unsplash

Contrary to popular belief, social security has not, nor ever will be, considered a salary replacement.

At the moment, Social Security benefits on average replace about 38% of past earnings. That number is expected to decrease to 35% in the future.

Note, that is an average. The higher your income, the lower the percentage. If your income is “low” (at 45% of the average wage or $24,239 in 2019) social security may replace half your income. If you make good money (more than 160% of the average wage or $86,182 in 2019) you may only see a quarter of your income replaced by social security.

You can check your Social Security benefits HERE.

And all that assumes that Social Security will continue to pay out as expected. Anecdotally many financial planners are making projections with the assumption that you’ll receive only 75% of what you think you’ll get.

For more on Social Security…

Fidelity has assumed that you will reduce your spending in retirement AND replace a big portion with social security. Fidelity seems to think you’ll only need to replace 45% of your pre-retirement income during retirement.

I don’t know about you, but this sounds very generous to me.

• According to Fidelity’s model, if you make 80K now, you’ll only need to replace 36K during retirement? Maybe Social Security will pay $28K? If you reduce your annual spending by 16K (80-36-28) it might work. Maybe.

The point is there is a lot of variability between individuals, especially at different income levels. I’m sure 45% was an accurate average, based on the historical behavior of a large population of people. But it doesn’t apply to individuals.

With our new understanding, this is how the two models compare.

• Charles Schwab’s multiplier at age 45 with a 15% savings rate is 9.4. Multiply 9.4 by 0.45 you get 4.23, which is now in the ballpark of Fidelity’s 4X at age 45.

At least this explains the big discrepancy between the two models.

What’s your overall return?

Fidelity and Charles Schwab use different rates to determine the growth of your retirement savings, both now and during retirement.

For mathematical ease, Charles Schwab simply went with a constant 6% rate of return. Considering that the S&P500 historically averages around 9% or so, and bonds much less, 6% seems reasonable.

However, we all have different tolerance for risk and a different time horizon. If you’re decades away from retirement you can be aggressive and put most of your retirement savings in the stock market. In contrast, if you’re only a few years away, you probably want most in more conservative assets such as bonds and cash equivalents.

Fidelity based their model on Target Date Funds (TDFs). If you’re planning to retire in 2035, you could invest in a 2035 Target date fund. These funds are designed to start out with a large allocation of stock early on, but over the years gradually become more conservative in their asset allocation.

For more on Target Date Funds…

Fidelity doesn’t indicate what type of “typical target date fund” they used in their model. Their investors have access to two types of Target Date funds, a regular managed fund, and an index fund, each available in five-year increments starting from 2005 to their new funds for 2065.

Their stated fund objective is to seek high total return until the target retirement date. Then seek high current income, and as a secondary objective, capital appreciation (growth).

Current asset allocation of some example Target Date funds

The asset allocation of the Fidelity Freedom® [year] funds. “Stock” = domestic + international stock allocations; “Bonds” = bonds + short-term debt allocations. Percentages rounded. Data from Fidelity.com, accessed September 2019.

If you retire next year (2020) your target date portfolio contains 56% stock. If you already retired over a decade ago (2005) you still have some stock, 29%, but mostly bonds.

If you are young (around age 19-34) and have decades to go (2050 and 2065), 93% of your portfolio is currently in the stock market.

These target date funds continue to be conservative during retirement. However, there is some recent data to suggest that gradually raising your stock allocation after retirement may be beneficial and reduce your risk of running out of money. This is called a rising equity glide path.

Limitations aside, the target date approach is much more realistic than an expectation of a constant 6% rate of return.

Image by Peter H from Pixabay 

How much do you save annually for retirement?

Fidelity simply assumes you are setting aside 15% of your annual income for retirement. That’s great, except not everyone does that. Not everyone can do that.

You may start out only putting aside a small percentage (as you have massive student loans to deal with). Then later, increasing that percentage.

The Charles Schwab model provides saving rate choices: 0%, 5%, 10%, 15%, 20%, 25%, and even 30%.

Note, the starting value here is different. This is a percentage of your annual retirement withdrawal amount, which is most likely smaller than your pre-retirement salary.

• If you are only able to save 5% at age 45, your multiplier is 10.9. If you need 52K to live on during retirement (after subtracting social security), then you should have ~570K in your portfolio right now.

Age and length of retirement

Fidelity assumes you’ll retire at age 67, consistent with the official Social Security retirement date. Schwab uses the more traditional—and realistic—age 65.

Once you retire, there is the small matter of whether your savings will last long enough. Fidelity assumes 26 years through age 93. Schwab assumes a bit longer, with 30 years lasting through age 95.

How long will you live? Keep in mind that we are all living longer than our parents. Actuarial averages are based on large populations. If you die early, then running out of savings isn’t an issue. However, if you live longer than expected, money may become an issue.

If there’s two of you (eg, a spouse), the odds that at least one of you will outlive expectations are much higher than if there’s only one of you.

For planning purposes, assume you’ll live longer.

Is there a “safe” withdrawal rate?

Most of us have heard about the 4% rule. Based on historical market data, multiple studies have shown that withdrawing 4% or less of your savings portfolio per year will allow it to last around 30-35 years.

Sometimes this is referred to as the “safe” withdrawal rate, which is misleading.

If there is ANY risk, you should NOT refer to something as “safe”

Instead, a more accurate description would be to describe success rate, or the odds you don’t run out of money before the end. The 4% rule, historically, has a high success rate.

The Schwab plan starts with a 4% initial withdrawal rate.

Mathematically, that is the same as using a 25X multiplier at the age you retire. If you need 80K annually, then your stash needs to be 2 million dollars (80K x 25).

From that initial assumption, all the other multipliers may be calculated for different ages and savings rates.

The Fidelity plan doesn’t specify their initial withdrawal rate, but it’s straightforward to calculate. If a retiree is withdrawing 45% of their final salary (1X salary) and they have 10X that final salary saved at retirement, then 45% of 1X is 4.5% of 10X. The initial withdrawal rate is 4.5%.

Moving forward, both models assume withdrawals are increasing for inflation, but its unknown whether the 4%/4.5% rate is maintained.

It should be noted that a 4% withdrawal over 30 years requires a portfolio of at least 25% stock (87% success), but preferably 50% stock (100% success).

This does not jibe at all with the Target date funds used by Fidelity, which drop below 17% stock.

Perhaps the high stock percentage in earlier years balances things out? Fidelity does state that the “average equity allocation over the investment horizon was more than 50%…”

Fidelity goes on to say that, based on historical market data, their model was successful 90% of the time.

Image by TanteTati from Pixabay 

The trap of historical data

The 4% withdrawal studies referred to above were based on the historical behavior of stocks and bonds. However, the last decade or so of low-interest rates have resulted in poor performance for bonds.

Finke M, et al. in their paper “The 4% Percent Rule Is Not Safe in a Low-Yield World” (2013) modeled two retirement portfolios, each containing 50% stocks and 50% bonds. In one portfolio interest rates stayed low, and in the second portfolio, rates started low but then returned to their historical average.

The failure rates of 4% withdrawal at 30 years were 33% and 57%, respectively

Running their model based on the usual historical averages resulted in only a 6% failure rate, well under the acceptable failure limit of 10%.

Important caveat: the authors are running their models based on certain assumptions about the future returns of stocks and bonds that may or may not pan out. The future might not be as bad. Or it could be worse.

Even if interest rates return to “normal” someone retiring today has less than a fifty percent chance of not running out of money if they use the 4% rule.

Ouch.

In addition to 4%, the authors also modeled withdrawal rates of 3%, 5%, and 6% using current market conditions and different allocations of stocks and bonds. No surprise, 5%, and 6% had high failure rates across the board.

At a 3% withdrawal rate, the lowest failure rate of 21% was achieved with an allocation of 70% stock. (60-100% stock had similar results.)

To achieve an “acceptable” <10% failure rate required a withdrawal rate of 2.5%

One of the authors, Wade Pfau, ran a separate analysis using today’s low-interest-rate environment at the start of retirement, generating results not quite as bad. At best 23% failure rate for the 4% withdrawal rate (100% stock) and only a 9% failure rate for the 3% withdrawal rate (60% stock, with similar results for 40-100% stock).

In short, a 4% withdrawal rate was never “safe”, but now it’s not even recommended. Stick to a 2.5% – 3% withdrawal rate instead.

Plus, average at least a 50% stock allocation during retirement.

In conclusion, both models that are intended to estimate your needed retirement savings at a given age have their limitations and should not be relied upon for your future planning. Instead, it’s better you do your own math—or better yet, have your financial planner do if for you.

Do the math several times using several different assumptions (different rate of return, different retirement age, etc.) and several different methods. See how the estimates vary.

This will give you a better idea of what you really need, and whether you’re currently on track. Or not.

Good luck!

Additional Reading

• Will Social Security Still Be There When We Need It? Most likely

• Target Date Funds. Is Neglecting Your Investments a Good Thing?

• Will You Run Out of Money? Closing in on retirement? How to manage your existing savings to last
• What is Your Portfolio Success Rate? Does the 4% rule still apply?

First photo credit: Peter H from Pixabay 

This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.