Who is more on track for retirement at age 66? A 25 year old that make $40,000 a year with $40,000 in student loan debt, that contributes 5% to their 401k, but who is paying $1,000 a month extra on their student loan while renting an apartment. Or a 50 year old who makes $100,000 a year, and saving 20% in retirement accounts, and has a total net worth of $500,000 including their paid for house, savings and retirement accounts.
The 25 year old is not contributing the 10-15% that so many experts are suggesting they contribute to their 401k. However, they are putting 30% a year extra towards debt reduction (not counting the principle that would naturally be in their student loan amortization). Another huge advantage they have, is they are getting used to living well below their means. If social security is projected to replace 40% of a typical person’s income, the 25 year old is already used to living off of 65% of their income after accounting for investments and debt reduction.
Assume an average 4% pay increase until age 66, 3% inflation, and a 5% overall return on all investments/assets (not just stocks, but a house or rental house they buy, bonds, CDs, savings, etc.). If they keep contributing 20% or more of their income into things that build net worth, then they should be able to support their lifestyle adjusting for pay increases and inflation until age 100. Since they are putting 35% of their income into paying down debt and retirement already, there is room to cut back some towards the 20% as they have changes or more responsibilities hit their budget.
On the other hand, the 50 year old has paid for their house, so they may not invest any more into real estate (replacing a roof or remodeling is maintenance, not an increase in investment, regardless of what the roofer says). They could be earning 8-10% a year on their 401k, but their house and other savings bring down their investment average to the same 5% return we are using for this example. They have 16 years to add to their net worth from their income, and they are used to living off of 80% of their income, and saving the other 20%, so social security will not bridge as much of a gap for them.
Making the same income increase, inflation, and investment return assumptions for the 50 year old, they need to invest/save 22% of their future income into net worth building assets (of any or all kinds) as opposed to the 20% they are setting aside just in retirement accounts. A 2% change in lifestyle spending should reduce their long-term needs, and the extra 2% in savings would help that last longer.
That means that the 25 year old is on a better path than the 50 year old because their lifestyle is lower, even though they have a negative net worth. The lower relative lifestyle, and longer investment time horizon makes all of the difference.
The charts below show a range similar scenarios ranging from someone with a negative net worth, to someone with 20x their income in net worth at a variety of ages. Please note that the charts and formulas are income-neutral, but social-security benefits might not be. The negative percentages are not typos; they are where someone can spend that percentage more than their income and run out of assets at age 100.
Retirement Needs Chart Based by Age and Net Worth
And for those who say “I don’t want to count on social security”, the link below is to the numbers assuming no future benefits from Social Security. The difference shows that the 25 year old how needed to save or invest 20% of their future income with social security, needs to save 32% without that benefit. You can also see in the chart that the 50 year old with $500,000 who needs to invest 22% with social security, faces a huge jump in savings need to 45% without social security. This is not to suggest that social security in some form won’t be there for people in the future, but it could be reduced, delayed, or fundamentally changed.
Retirement Needs Chart WITHOUT Social Security
Hopefully this provides some context for a financial checkup, or building a broader plan that just a stocks and bonds in a 401k. Here are some things to think about when looking at these numbers:
1) If you need to save 30% under this model, that means your consumption is projected at 70% of your income going forward, and adjusted for inflation after retirement. These numbers assume a flat lifestyle relative to your income.
2) The 5% investment return (2% real return over inflation) comes from the mixes of assets in a typical person’s net worth, taxes, transaction fees, and so forth. This is consistent with those believing in an 8-10% return in the stock market over the long term.
3) The charts are for surviving until 100, and then having $0 in net worth. There were no adjustments for rising healthcare expense, but also no adjustments for the money saved in retirement by reducing expenses related to working, and lifestyle.
4) When calculating how much you are currently contributing to you net worth each year, add up your retirement investing, long-term savings, the principle portion of any debt you are paying off and money going into other value-building assets. Any new debt you accrue (for any reason), should be fully subtracted from your net worth contribution.
5) No considerations were made for taxes, but in the current US tax code, there are lots of tax shelters and exemptions, so if you maintain the same types of assets, standard of living, and expenses then hopefully you’ll maintain a roughly equivalent effective tax rate with some planning.
6) It is safe to say, no single person reading this has or will experience exactly 3% inflation, 4% pay increases, or a 5% return on investment, and a 40% income placement in social security. This is not prescriptive advice, but a way of building out the traditional rules of thumb beyond just “stock investing”.