How Much Should You Save Each Year?

There’s ample research about how much you can safely withdraw from your portfolio once you retire. There’s less research about how much you need to save annually so you can retire (this is called your “savings rate”), probably due to the large number of variables that exist.

It’s easy enough to say you should be able to “safely” withdraw 4% from your portfolio in your first year of retirement and increase it annually for inflation without fear of running out of money. It’s harder to say how much you need to save each year because you may have started saving earlier (or later) than the next person, your earnings may differ, your lifestyle certainly differs, and you will probably retire at different ages.

Yet, while your situation is unique, it’s still possible to get a general idea of how much you need to be saving.

To do so, I am using the following inputs: a 35-year-old woman who earns $100,000 and who has already saved $100,000. She plans on working until she’s 65 and will receive Social Security of $32,238 in today’s dollars at age 67. When she retires, she wants to replace 75% of her income (this is her “replacement rate”), or $75,000, adjusted for inflation. Her investments earn 7% before she retires and 5% afterwards. We are not accounting for taxes during retirement and she lives to age 94.

It turns out she needs to save 17% of her income each year to have a financially secure retirement. Coincidentally, that’s almost exactly the amount she can contribute to her 401(k). (The current IRS limit for someone under the age of 50 is $19,000.)

Now, what if everything remained the same but she earns $200,000 and wants to replace 70% of her income (down from 75% to reflect higher taxation while she’s working)? In that scenario, she would need to save 21% of her income, or $42,000 per year.

Increase her earnings yet again, this time to $300,000, and decrease her replacement rate to 65%, and she would need to save 23%, or $69,000.

There are three things we should learn from this quick exercise.

First, the old days of “Save 10% of your income!” are long gone. Even if you earn $100,000, you need to save almost twice that percentage each year. And as your earnings increase, the amount you need to save, both in dollars and percentages, must increase. This is largely due to the cap on Social Security benefits: In 2019, someone who averaged $100,000 in annual earnings is entitled to $32,238 in benefits while someone who averaged $300,000 in annual earnings would only receive $44,376. The former person has nearly half of their retirement expenses replaced by Social Security ($32,238/$75,000 = 43%) while the latter replaces less-than-a-quarter ($43,376/$195,000 = 23%).

Second, you must have a game plan for handling salary increases, no matter how large or small. The bigger the pay increase, the more important it is to have a plan for how much of that you’ll save and how much you’ll spend. The last thing you want to do if your salary goes from $100,000 to $150,000 is spend all of the increase because you won’t be able to sustain that in retirement.  Here’s a rule you’d be wise to follow anytime you receive a raise: save half, spend half.

Third, contributing the max to your 401(k) isn’t enough (though if you earn $100,000, then it’s probably alright). If you’re earning $300,000, the top end of my example, saving $19,000 to your 401(k) equates to less than 7% of your earnings. I can think of a few times that I’ve sat down with people in their early 60’s who were thoroughly unprepared for retirement as they explained they “always maxed out” their 401(k). That’s just not enough. As your income increases, you need to be saving over and above your 401(k) contributions.

As an aside, you should not include any match you receive from your employer when figuring your savings rate. The reason your savings rate is so important is that not only does it show how much you are putting away, it also acts as a cap on how much you are spending. A higher savings rate simultaneously means a lower spending rate. This is another reason why planning ahead for large salary increases is so important. By capping your spending, you aren’t beholden to a high paying job. If that job disappears, it’s easier to step into one that pays less, if necessary.

As I mentioned above, there are many different variables that can increase or decrease how much needs to be saved each year. Young kids can increase your expenses while you’re working, but as they move out your expenses may be lower. A married couple will be entitled to at least one-and-a-half Social Security benefits. You may want to work past age 65. The variables go on and on.

So, while the above examples are averages, which can be problematic, they do provide a good framework for assessing whether you’re saving enough, which can be really helpful for young investors who have no idea what they want their life to look like 20, 30, sometimes 40 years down the line. In the absence of clearly defined retirement goals, look to your savings rate.

Better yet, work with us to see how much you need to save for your unique goals. Not only will you know how much you need to save for tomorrow, you’ll know how much you can enjoy today.

Enjoy your weekend!

PS: if you’re curious to see how I arrived at these numbers, send me an email and I’ll forward along my spreadsheet.

Ryan Smith
[email protected]

Born and raised on the North Shore of Massachusetts, I moved to Raleigh in 2011 to marry my wife, Emily. We have two kids, Jack and Gwen, a golden retriever named Olly, and are members of Church of the Apostles. I have been a Financial Advisor since 2005 and earned a Master’s of Science in Financial Planning from Bentley University in 2007. I became a CFP® professional in 2009, a Retirement Income Certified Professional® in 2015, and a Certified Tax Specialist™ in 2023.