Percentage savings of gross or net income?

[emailforian]

We often hear percentages of income given as a guideline for
retiremement savings. For example, I have heard that you should save a
minimum of 10 percent of your income for retirement savings, and that
if you can save as much as 20 percent or more, you are really doing
well. But here is my question..... a percentage of WHAT?? Is it gross
income or net income? Does it include employer matching contributions
as income?

Let's use some hypothetical numbers to illustrate my question. Let's
say a person (or a couple) earns 100k per year, and they get a 5
percent match for their retirement plan (which they contribute to in
order to get the match), and their income taxes (including federal, SS,
medicare and state taxes) are 20k. (This may or may not be realistic
for some people, but let's just go with these hypothetical numbers for
sake of an example). Let's also assume that this hypothetical person
or couple saves 15k per year (which includes the 5k in employer
matching contributions).

Now, my question is......what percentage of income is this person or
couple saving? Is it 15 percent? (15k/100k gross income, excluding
match). Is it 14.28 percent? (15k/105k including the match as
income). Is it 18.75 percent? (15k/80k after tax income).

I know some of you will say, "what does it matter, so long as you are
saving enough to meet your goals, who cares what percentage it is."
That is a fair answer, and I already accept that as a valid point.
However, I am still curious to know what the standard or convention is
in terms of quoting percentage of income savings goals.

 

[joetaxpayer]

We often hear percentages of income given as a guideline for
retiremement savings. For example, I have heard that you should save a
minimum of 10 percent of your income for retirement savings, and that
if you can save as much as 20 percent or more, you are really doing
well. But here is my question..... a percentage of WHAT?? Is it gross
income or net income? Does it include employer matching contributions
as income?

Let's use some hypothetical numbers to illustrate my question. Let's
say a person (or a couple) earns 100k per year, and they get a 5
percent match for their retirement plan (which they contribute to in
order to get the match), and their income taxes (including federal, SS,
medicare and state taxes) are 20k. (This may or may not be realistic
for some people, but let's just go with these hypothetical numbers for
sake of an example). Let's also assume that this hypothetical person
or couple saves 15k per year (which includes the 5k in employer
matching contributions).

Now, my question is......what percentage of income is this person or
couple saving? Is it 15 percent? (15k/100k gross income, excluding
match). Is it 14.28 percent? (15k/105k including the match as
income). Is it 18.75 percent? (15k/80k after tax income).

I know some of you will say, "what does it matter, so long as you are
saving enough to meet your goals, who cares what percentage it is."
That is a fair answer, and I already accept that as a valid point.
However, I am still curious to know what the standard or convention is
in terms of quoting percentage of income savings goals.

I ran a spreadsheet with numbers that gave me this result;
Start at $30K income, inflate at 3%,save 10% of gross income, an
investment return of 10%, starting at age 20 through age 60, and you
will have $1.99M or 20.33 times your final year salary of $100,797.

You can change whatever assumption you will, but the savings is gross
when people here say "save x%"
If you can only save 5% but it's matched by an employer, that's ok too.
There's nothing wrong with saving more, as I thing we may start be
leaning toward the belief that long term, returns may trend a bit lower
than the past 20 years, 8% is now what I use for the long term. (at an
8% return, a 15% saving rate is needed to meet the 20X goal) It's also
ok to start out saving a bit less, with an eye toward saving, say 1/3 of
each raise as you get raises/promotions.

You realize also, that while it's easy to throw out numbers, one must
review their position and goals every so often. People who live well
under their means may very well find they are able to retire on a
smaller fraction of their pre-retirement income.
JOE

 

[Bucky]

But here is my question..... a percentage of WHAT?? Is it gross
income or net income? Does it include employer matching contributions
as income?

Good question. My interpetation for that rule of thumb is 10% of gross,
and you can include employer matching contributions.

 

[Elle]

We often hear percentages of income given as a guideline
for
retiremement savings. snip for elegance
But here is my question..... a percentage of WHAT?? Is it
gross
income or net income?

On the assumption that this rule of thumb actually has some
value, gross is what is meant.

Does it include employer matching contributions
as income?

No, because you can't get at that matching portion without
facing penalties or being in some hardship situation.

The rule of thumb is based on having the same amount of
gross dollars per year in retirement "to spend as one
wishes" as one has while working. While one is working, one
does not have the matching portion "to spend as one wishes,"
so the matching portion does not count.

I can only loathe the 10% or 20% or thereabouts rule, since
it expects people to blindly trust.

At the moment, and assuming a person is living reasonably
comfortably (not scrooge-like or in poverty), I think the
better guidance is to
1) max out the matching portion of one's 401(k), to get the
immediate 50+% return on one's money.
2) max out a Roth IRA, for the tax advantage.
3) resume contributing to the 401(k), to get the tax break.

Some adjustments may be allowed for purchasing a
non-ostentatious house (unless one is rolling in dough, I
guess) and the annual family vacation. But the worst case
outcome of the above is that one will be able to retire
sooner, rather than later.

If a person is living in poverty to meet the goals above,
and sees no way out or job advancement, then career planning
is needed: Income must be raised.

The only people to whom this guidance might not apply have
such high incomes they are ineligible for a Roth IRA. In
this instance, though, retirement saving should not be a
matter of planning to survive without being on welfare but
instead more an estimate of how revoltingly materialistic
(or perhaps philanthropic) one wants to be in one's elder
years.

 

[BreadWithSpam]

We often hear percentages of income given as a guideline for
retiremement savings. For example, I have heard that you should save a
minimum of 10 percent of your income for retirement savings, and that
if you can save as much as 20 percent or more, you are really doing
well. But here is my question..... a percentage of WHAT?? Is it gross

You can write simulations which take all sorts of these
things into account.

I have a short program I wrote which does roughly this kind
of math - it takes a savings rate, a goal multiple (ie. 25x)
and runs a loop savings one's savings percantage and compoundng
the growth until the savings is 25x one's total income. I
used total income because the savings are all assumed to be
in one's 401k and will be taxed at the end - but this doesn't
take into account the fact that one's actual spendable income
is lower - by exactly that savings rate. So I modified it
by assuming that one's goal is 25x (income - savings_rate).
Savings 20% and assuming away inflation by using only 7%
as the rate of return, it takes 30 years to save 25x one's
spendable income - and 33 years to save one's current gross.

Cranking up savings to 25% and investment returns to 8%
makes it take 25 years to save 25x spendable income -
where spendable income is lower (75% of current income)
because of the higher savings rate.

There are a million tweaks to the program we could make -
the rate of return could be lowered over time as one makes
more conservative investments - income could grow faster
than inflation (it actually tends to), taxes could be factored
in, as well as both pre-tax, tax-deferred, Roth, etc style
savings. A spending drop after 30 years if we assume that
a mortage has been paid off over tha time. There are so
many factors that one has to simplify somewhere.

The bottom line, though, is that the percentage of income
to save is only a rough rule of thumb, as is the goal multiple
of 25x income (to generate 4% drawdowns). As you can see,
even saving at a rate that's fairly aggressive (25%) still
requires *decades* of saving. What one really needs to do is
start somewhere - and after a while, evaluate what one's
saved and see if one's been saving enough. For example, using
the first set of numbers (20% savings, 7% growth, 25x spendable
target and 30 years to save) - after 10 years, one should have
3x one's current spendable income saved. If it's not enough,
crank up the savings. If one's saved more than 3x at that point,
well, I'd say keep it up - save more earlier and possibly retire
earlier. But one needs to use these rules of thumb not as
laws but rather as guidelines in a larger analysis over time.
They are meant to be easy means of helping folks get moving.

 

[joetaxpayer]

Elle wrote:

snip

I can only loathe the 10% or 20% or thereabouts rule, since
it expects people to blindly trust.

At the moment, and assuming a person is living reasonably
comfortably (not scrooge-like or in poverty), I think the
better guidance is to
1) max out the matching portion of one's 401(k), to get the
immediate 50+% return on one's money.
2) max out a Roth IRA, for the tax advantage.
3) resume contributing to the 401(k), to get the tax break.

snip

Sorry if I over-snipped.
Why you do feel the rules of thumb expect blind trust?
In my earlier reply I gave some pretty hard numbers, 10% savings/10%
return/ 42 years of work resulted in the 20X saved amount.
That statement at least is a starting point, I stated the 10% return
moving forward was likely on the high side, so savings would need
adjustment up (or through matching) if we assume an 8% return.

These 'rules of thumb' are what I try to share with every young person I
meet who's just getting started. They tend to work for companies with a
match, and if they don't see the 10% from their first paycheck, they are
likely to stick with the savings plan.

Your order above is my exact advice, that will cover people making right
up to $190K/($380K couple). Of course at some point they need to review
the status of their current tax rate vs future (retirement) projected
rate. The new ROTH401 should help that dilemma.
JOE

 

[jIM]

I can only loathe the 10% or 20% or thereabouts rule, since
it expects people to blindly trust.

At the moment, and assuming a person is living reasonably
comfortably (not scrooge-like or in poverty), I think the
better guidance is to
1) max out the matching portion of one's 401(k), to get the
immediate 50+% return on one's money.
2) max out a Roth IRA, for the tax advantage.
3) resume contributing to the 401(k), to get the tax break.

The guidelines above suggest the vehicles to save in, and indirectly
suggest how much. A person would have to figure out the matching
percentages, make a decision based on that number and open numerous
accounts (401k, Roth IRA, other). A person might only do step 1 and
not "save enough" based on the percentage factor discussed in original
post.

Not that any of above is bad information or misinformation- what is
posted above is true and factual.

My personal opinion is a person should save a percentage to follow the
guideline of "live below your means". 10% is the primary starting
point, more is better. Where this 10% goes (401k, Roth IRA, other) is
not as important as the percentage. Save 10%- you will do well. save
15% you will do better (all other things being equal). Force yourself
to save.

I think using the 401k for first 10% of savings is a good way to start.
Whether matching is 3%, 5% or 10%. My company has been bought and
sold so many times I do not know what my exact match was at any given
time. I checked to make sure match existed, and I was contributing
enough to get it... I always saved the same percentage (10%). My Roth
IRA is extra savings on top of this.

In addition, some 401ks now have a "one step" (that is what Vangueard
calls it) where each year the 401k contribution percentage is
automatically increased. I suggest people set this to 1% per year (so
10% savings rate this year is 11% next year).

One other guideline I have read is to put raise percentage in the 401k.
Make 100k, get a 2% raise (102k) increase 401k rate 2% as well.

 

[jIM]

Let's use some hypothetical numbers to illustrate my question. Let's
say a person (or a couple) earns 100k per year, and they get a 5
percent match for their retirement plan (which they contribute to in
order to get the match), and their income taxes (including federal, SS,
medicare and state taxes) are 20k. (This may or may not be realistic
for some people, but let's just go with these hypothetical numbers for
sake of an example). Let's also assume that this hypothetical person
or couple saves 15k per year (which includes the 5k in employer
matching contributions).

Now, my question is......what percentage of income is this person or
couple saving? Is it 15 percent? (15k/100k gross income, excluding
match). Is it 14.28 percent? (15k/105k including the match as
income). Is it 18.75 percent? (15k/80k after tax income).

10% is answer I use (10k of 100K Gross Income). The match is not part
of the saving percentage (because it is not "income").

 

[joetaxpayer]

jIM wrote:

My company has been bought and

sold so many times I do not know what my exact match was at any given
time. I checked to make sure match existed, and I was contributing
enough to get it... I always saved the same percentage (10%).

This is a key point to emphasize.
My company matches dollar for dollar, the first 5%. I found coworkers
who said they 'couldn't afford' to save more than 2 or 3%, not
understanding the match. Ten minutes of me and a spreadsheet, and they
(I'm not just being gender neutral, there were 4 or 5 people in this
boat) bumped to 5% to get the match.

Other than that echoing of your point, I think there's consensus on the
original thread's topic. A good FAQ point, Tad.

JOE

 

[Tad Borek]

We often hear percentages of income given as a guideline for
retiremement savings. For example, I have heard that you should save a
minimum of 10 percent of your income for retirement savings, and that
if you can save as much as 20 percent or more, you are really doing
well. But here is my question..... a percentage of WHAT?? Is it gross
income or net income? Does it include employer matching contributions
as income?

This is kind of like the tipping rule - have you been out to dinner with
someone who insisted that you don't tip on the tax? And who gets really
adamant about it? OK fine but what's the tipping percentage? "Oh, maybe
15% to 25% depending on the circumstances, and I usually round to the
closest dollar."

There's a lot of slop in any long-term projection like this and it's
going to be so specific to the individual. But as Joe posted you can put
together rough savings projections that show how long it takes to
accumulate enough money to retire, in the sense of "quit working with no
change in lifestyle." These are highly dependent on assumptions, of
course, but by a few different approaches three of us came to similar
numbers - that at a 20% savings rate, starting from zero, you could get
to that point in about 40 years, or fewer. On my 3-minute Excel
projection that meant 20% of gross income, and it wouldn't matter if it
came from a 401k or a gift from your Uncle Lou. You just need 20% of
this year's gross income landing in an investment account that you don't
touch until you retire. Again, it's just a rough projection and you
could spend a lot of time tweaking it for things like taxes and changes
in earnings.

I'd also add that most people never get to the point of accumulating
enough wealth that they can replace their income. And anyway, you
probably don't need to replace your income entirely during retirement
(especially factoring in Social Security). So this is an aggressive kind
of goal.

At 10% it takes quite a bit longer, maybe 10+ years, or you simply end
up being able to replace a lower percentage of your income when you do
retire. Which may be perfectly acceptable of course.

There was a long thread on MIFP about all this recently entitled "Invest
now, or should I wait?" - you can find it using the Google search
function (go to "groups" in google).

-Tad

 

[zxcvbob]

At 10% it takes quite a bit longer, maybe 10+ years, or you simply end
up being able to replace a lower percentage of your income when you do
retire. Which may be perfectly acceptable of course.

There was a long thread on MIFP about all this recently entitled "Invest
now, or should I wait?" - you can find it using the Google search
function (go to "groups" in google).

-Tad

If you are saving, say, 15% of your income, you don't need to replace
your whole income to maintain your standard of living, you'd only need
to replace at most 85%. Think about it.

Best regards,
Bob

 

[joetaxpayer]

If you are saving, say, 15% of your income, you don't need to replace
your whole income to maintain your standard of living, you'd only need
to replace at most 85%. Think about it.

Best regards,
Bob

Bob, at some level, your observation is correct.
I had the privelege to meet Astronaut James Lovell, whose claim to fame
is having been played by Tom Hanks in the movie Apollo 13. In his speech
he remarked how they got to the moon while at any given moment they were
aimed somewhat nearby, never right there.

Since the 15% is a target, based on too many variables, return,
age/health at retirement, etc, it's too premature to try to tinker with
the actual goal. 100%, 85%, 50%??

As I whittle away the expenses I won't have at retirement, mortgage,
college savings, retirement savings, I quickly find that 40% or more of
my monthly outlay won't be there when I retire. But I keep the goal at
100% just as a target. Worst case, I'll leave a nice inheritance and
fund some charities. Best case, it will be a crash-proof (i.e. it will
survive a crash and not impact our spending) portfolio that will give
the Missus and me unlimited options.
JOE

 

[emailforian]

If you are saving, say, 15% of your income, you don't need to replace
your whole income to maintain your standard of living, you'd only need
to replace at most 85%. Think about it.

Best regards,
Bob

Bob, that's true. Also, if you intend to rely on investment income
alone, you also don't have to pay approximately 6% towards social
security anymore, so you only need to replace 79% of your
pre-retirement income.

With that being said, some people plan to spend more time doing
relatively expensive activities during retirement to fill up all of
that time previously spent working, such as travel, certain hobbies,
maybe buy a boat, etc. So the actual cost to maintain a desired
retirement lifestyle for some people may actually increase relative to
the cost of their pre-retirement lifestyle.

 

[Elle]

snip
Why you do feel the rules of thumb expect blind trust?

The 10%-20% savings "rules of thumbs" assume a person does
not want to improve his or her standard of living, for one.

It's my now nearly regular gripe: There are too many
assumptions that folks are all making a decent wage and will
throughout their lives.

snip

These 'rules of thumb' are what I try to share with every
young person I meet who's just getting started.

As I've stated before (in another thread a week or so ago),
I don't have a huge objection to this rule of thumb,
especially for a young, professional person. Who, still,
probably has either poor math skills, poor budgeting skills,
or parents who never discussed saving for retirement at the
dinner table (or saving period).

Unless the basis for this guideline is explained and
understood, then the young person is being asked to blindly
trust that his current income, with raises reflecting
inflation and possibly some career growth, will leave
him/her comfortable in retirement. Not necessarily so.
Consider the kid who is working at Wal-Mart and following
your guidance. It's a mistake to think a person can escape a
retirement of poverty by simply saving 10% to 20% a year of
their gross income. Sometimes a radically different plan,
having nothing to do with what fraction is saved, is
necessary.

They tend to work for companies with a match, and if they
don't see the 10% from their first paycheck, they are
likely to stick with the savings plan.

That's somewhat of a different issue. FWIW, I agree about
how never seeing the 10% will ease the pain of saving
regularly for retirement.

Your order above is my exact advice, that will cover
people making right up to $190K/($380K couple).

I thought the AGI limits were $110k for single people, $160k
for married.

Of course at some point they need to review the status of
their current tax rate vs future (retirement) projected
rate.

Yearly review is what I think is appropriate. This will help
refine decisions made on mere rules of thumb, for one thing.
Saving for retirement is a dynamic process, not a one-time
decision, etc.

 

[joetaxpayer]

I thought the AGI limits were $110k for single people, $160k
for married.

Yup, I made a faux pas here. I was doing the math backwards, using the
10% figure and the combined total of $15K+4K for 401 and IRA, I meant
that the advice covers most people. But you are quite right that Roth
stops at the levels above. My numbers hold if you flip to non-deductable
IRA. Which, by the way, in 2010(?) we wil be allowed to convert to Roth
without penalty. That you for the fact-check.
JOE

 

[Tad Borek]

Consider the kid who is working at Wal-Mart and following
your guidance. It's a mistake to think a person can escape a
retirement of poverty by simply saving 10% to 20% a year of
their gross income.

I strongly disagree. In fact much of my personal inspiration comes from
individuals who made enormous leaps through that sort of scenario.

Granted there is a certain percentage of America that is at the level of
privation, to borrow Galbraith's favorite term, and they just don't have
the dollars to devote to savings. But beginning relatively early in the
earnings scale, people begin to divert a great deal of money to wholly
discretionary spending. By definition if it's discretionary, it can be
saved instead, and it doesn't need to be spent during retirement -
raising the savings level, lowering the retirement-savings need.

Satellite TV w/premium channels, cell phone, low-mileage vehicle, too
much house, buying on consumer credit - these are very common
consumption choices that can easily represent a marginal 10%+ of income.
Actually, car choices are a big part of it, because any of them can
require a $1500 repair, which might represent 5% or more of income for
many people.

-Tad

 

[jIM]

I strongly disagree. In fact much of my personal inspiration comes from
individuals who made enormous leaps through that sort of scenario.

I agree with Tad on this. The person working at Wal Mart as an hourly
employee has the added advantage that to maintain their standard of
living, they need to save a lower overall amount than the "rest of us".

The resulting nest egg will be smaller. But the "lifestyle" they had
to live on with 90% or 80% of their gross pay from Wal mart is a much
more frugal lifestyle than I could imagine. They would need less
savings to maintain this.

Incremental saving percentages (changing from 10% to 12% savings rate,
for example) would probably improve this Wal mart employee's standard
of living in retirement much more than if I increased mine 2% or Bill
Gates increases his savings rate 2%.

This guideline of "absolute percentage" works better for lower income
workers, IMO.

 

[Douglas Johnson]

I agree with Tad on this. The person working at Wal Mart as an hourly
employee has the added advantage that to maintain their standard of
living, they need to save a lower overall amount than the "rest of us".

I don't want to kick off a debate about the viability of Social Security, but
currently, our friend at Walmart will have a much larger percentage of their
income replaced by Social Security than higher wage workers, so their required
savings will be significantly less.

It is also worth pointing out that this discussion of saving percentage has
focused on saving for retirement. You also want to save for other purposes,
including down payments on houses, purchase of cars and other major items,
college tuition....

This saving is in addition to the retirement savings being discussed.

-- Doug

 

[jIM]

I don't want to kick off a debate about the viability of Social Security, but
currently, our friend at Walmart will have a much larger percentage of their
income replaced by Social Security than higher wage workers, so their required
savings will be significantly less.

Doug kicked in my next point- SS is a higher percentage of income, so a
smaller nest egg is needed.

 

[joetaxpayer]

I don't want to kick off a debate about the viability of Social Security, but
currently, our friend at Walmart will have a much larger percentage of their
income replaced by Social Security than higher wage workers, so their required
savings will be significantly less.
snip

-- Doug

Right. www.ssa.gov will give an estimate of benefits.
Someone earning $20K this year and retiring (assuming similar level of
earning going back (to just $5400 in 1984 for example*) will receive
$6684 per year, not great, but 33% of their prior earnings. I don't know
if Walmart does a 401 match, but a 3.5% deposit, 3.5% match will get
this person up to replacement income.

*I think the web page underestimates prior income. In 1984, minimum wage
was $3.35, or $6968 for the year. That would bump the benefit up a bit
further.
JOE