How much does someone need to save to retire?

Answer 1

Rather a lot. Imagine that we want to work a year, then take a year off work. It's pretty clear that during the work year we need to save half our pay in order to have the same spending during the year off.

Same logic if we want to work from 25 to 55 and to be retired from 55 to 85. Each year of work has to pay for two years of spending: the work year and one of the retired years. So we have to save half of our pay.

But wouldn't interest help reduce that 50% of pay required savings rate? Well, we all used to think so. But the Stock Market in 2009 is back to where it was in 1997, and sophisticated investors and institutions are buying Treasury Inflation Protected Securities (TIPS in the US, inflation-indexed bonds etc elsewhere) yielding 2%. So a reasonable (most would say pessimistic) assumption about the after-inflation, after-tax, after-expenses long-term safe yield on your assets is zero. So interest doesn't help.

In reality, working beyond 55 and maybe beyond 65 looks like the trend. Working 40 years, being retired 20 years would need a savings rate of 33.33% of pay using the above logic. Kick in some help from the government, employer etc and the required rate could reduce more. Most defined benefit corporate pension plans have recommeded combined employee/employer contribution rates below 20% of pay, but typically they assume lots of (cheap) resignations and layoffs, and little or no inflation indexation after retirement.