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Why You May Need to Save Twice As Much for Retirement As Your Parents

A woman checks her retirement portfolio using her phone. Research from Morningstar suggests those planning for retirement may need to save twice as much as current retirees.

How much will you need to save before you can retire? It’s a simple question at the root of most people’s plans for their golden years. Answering it, however, can be far more complicated.

Using research that reexamined the viability of a popular retirement planning strategy known as the 4% rule, a Morningstar portfolio strategist found that current savers may need to stash away twice as much money each year compared to the past savings rates of people who are already retired.

A financial advisor can help you assess your income needs in retirement and devise a plan to meet them. Find a trusted advisor today. 

Updating the 4% Rule

A jar of quarters signifying a person's retirement savings. Research from Morningstar suggests those planning for retirement may need to save twice as much as current retirees.

For decades, the 4% rule has been a pillar of retirement planning. This basic rule of thumb, developed by financial planner William Bengen in 1994, dictates that retirees can stretch their savings over 30 years by withdrawing 4% of their nest egg in the first year of retirement and adjusting subsequent withdrawals for inflation each year. This simple strategy aims to provide steady and reliable income for retirees with balanced portfolios (50% stocks, 50% bonds)

The classic example often used to illustrate the 4% rule a retiree with $1 million in retirement savings. Using the 4% rule, this hypothetical retiree would withdraw $40,000 in their first year of retirement, and then increase subsequent withdrawals by the rate of inflation. Doing so will all but ensure they won’t run out of money for at least 30 years.

But Morningstar researchers say low bond yields and an overvalued equity market are the primary reasons a 4% withdrawal rate “may no longer be feasible.” Instead, they found that 3.3% is a more appropriate initial withdrawal rate for retirees with balanced portfolios who are seeking fixed annual retirement income.

By initially withdrawing only 3.3% of their portfolio, a retiree has a 90% probability of maintaining a positive account balance after 30 years, Morningstar found. The heavier the portfolio’s equity position, the lower the initial withdrawal rate should be.

Why You Need to Save More

A couple checks their retirement portfolio using a laptop. Research from Morningstar suggests those planning for retirement may need to save twice as much as current retirees.

Amy C. Arnott, a chartered financial analyst and portfolio strategist at Morningstar, explored two possible implications of the new 3.3% withdrawal rate in her recent piece, “What Lower Withdrawal Rates Mean for Retirement Savings.”

First, a retiree who needs to generate $40,000 in annual income will need to have more saved by the time they begin withdrawing their money if their initial withdrawal rate is 3.3%. While a person following the 4% rule could withdraw $40,000 during their first year of retirement, Arnott calculated that someone adhering to the new 3.3% withdrawal rate would need $1.21 million in savings or 21% more than a person following the 4% rule.

Second, people who are still years or decades away from retirement may face stronger headwinds that could limit their returns compared to current retirees, Arnott wrote.

“Because of the twin perils of low starting yields on bonds and historically high equity valuations, retirees are unlikely to receive returns that match those of the past investors who are currently close to retirement age have benefited from favorable market tailwinds over the past three to four decades,” she wrote. “But younger investors may need to save considerably more to build up enough savings to sustain withdrawals when they eventually retire.”

How much more will younger investors need to save each year? Approximately double.

Arnott found that a 30-year-old who started saving for retirement in 1985 could save $5,000 per year and build a $1.212 million nest egg by age 65. (Her calculation assumes a 60/40 split between equities and bonds, as well as annual returns that are “in line with market averages.”)

However, a 30-year-old investor today with a 60/40 balanced portfolio earning 6.2% per year would need to save twice as much as the investor from above. More precisely, a 30-year-old today must sock away $10,296 annually for 35 years in order to reach the $1.212 million plateau that needed to support a 3.3% withdrawal rate.

This may be daunting for many, but Arnott says investors should not despair. If saving more is not possible, they can incorporate non-portfolio strategies, like delaying Social Security.

“Some of the major strategies include forgoing the inflation adjustment after any years when your nest egg loses value, employing a ‘guardrails’ strategy that involves cutting back on withdrawals in down markets but giving yourself a raise in good ones, or using required minimum distributions to determine the withdrawal amount,” Arnott wrote.

Bottom Line

Recent research from Morningstar calls into question the viability of the 4% rule for retirement withdrawals. The financial services company found that 3.3% is a safer initial withdrawal rate for retirees looking to establish a fixed and reliable income for 30 years. However, this lower withdrawal rate means retirees must save more, Morningstar’s Amy C. Arnott wrote. In fact, a 30-year-old today may need to save twice as much per year as current retirees saved on a yearly basis during their careers.

Retirement Planning Planning Tips

  • A financial advisor can help you create a plan to generate income in retirement. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Calculating how much money you’ll have saved by the time you retire isn’t as complicated as you might think. SmartAsset’s Retirement Calculator can help you estimate your retirement savings based on a number of factors, including your Social Security election age and your monthly savings rate.
  • Speaking of Social Security, the longer you delay collecting your benefits, the more valuable those benefits will eventually be. After reaching full retirement age, your eventual benefit increases every month until you turn 70. If you were born in 1960 or later, delaying Social Security until 70 will hike your benefits by 24%.

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