You Should Be Saving at Least 12% of Your Pay for Retirement. Here's Why

To reach retirement in solid financial shape, you likely need to up your savings game today.

Vanguard reports that the median 401(k) contribution of American workers is 6% of pay. After adding in the median company matching contribution, the total workers are setting aside falls just short of 10%.

That may not be enough. Vanguard recommends a total contribution rate of between 12% to 15% of salary.

But you may want to save even more, depending on your situation and on how you expect stocks to perform in the future.

The Center for Retirement Research at Boston College looked at the “what to save” question a few years ago. Their analysis was based on the goal of saving enough to replace 80% of your pre-retirement income once you've stopped working -- a common benchmark used by financial advisors.

Researchers' recommendations varied based on annual income, the age when someone started saving, and the expected rate of return (after inflation) for a retirement portfolio.

If You Got a Late Start, Make up for Lost Time

A 25-year-old in 2010 who had “medium” earnings of $43,000 would need to save 12% a year to retire at 67 in solid shape, assuming a 4% after-inflation rate of return. If you waited until age 35 to start saving, you would need to save 18% a year. Retiring before 67 would require more savings, while working until age 70 would reduce the savings rate needed.

The more you earn, the more you likely need to save to maintain your standard of living in retirement. This is because Social Security will replace a smaller portion of your income than it does for lower earners. The CRR study found that a “maximum" earner in 2010 ($106,800) would need to start saving 16% of salary starting at age 25, or 25% of salary at age 35 to be in solid shape at age 67, assuming the same 4% inflation-adjusted annualized rate of return.

Don't Count on Stocks Continuing to Outperform

And banking on a 4% real rate of return may be a bit optimistic over the next decade or more. The fact that U.S. large cap stocks have delivered an annualized gain of 15% over the past 10 years should not be projected into your future. This very long bull market means stock valuations are high, and bond yields remain below half their long-term historic norms.

Research Affiliates, an institutional investment firm, produces a monthly estimate of what different types of investments might return over the next 10 years, based on its analysis of current valuation levels and growth expectations. Research Affiliates’ median expected annualized return for U.S. large cap stocks is paltry: less than 1% over the next 10 years, adjusted for inflation. Low-yielding bonds are expected to deliver much the same.

If portfolio returns are lower going forward, your savings rate becomes ever more important. In other words, if the markets aren’t going to do the heavy lifting, you'll need to pick up the slack by saving more.

Retirement planning experts David Blanchett, Michael Finke and Wade D. Pfau published a research paper a few years ago that made the case that lower returns should be baked into long-term retirement planning.

“Investors facing inflated asset prices, and the lower expected future returns they imply, must accept the reality that they will need to save more to maintain their lifestyle in retirement, ” the researchers wrote.

That’s especially true if you’ve started working or changed jobs in the past few years and were automatically enrolled in your workplace retirement plan. According to Vanguard, among plans that auto-enroll workers, nearly half start workers at a contribution rate of 3% or less; fewer than a quarter start workers at a contribution rate of at least 6%. Even with a company match, that is not likely going to get the job done.

For 2019, younger workers can contribute a maximum of $19,000 to a 401(k); if you're 50 or older, the limit is $25,000.