December 11, 2017 0 comment

What percentage of my income do I need to save in order to have enough to retire? Many factors affect the answer including how much income you make above the maximum threshold for payroll taxes.

I was recently working with a client on a retirement projection. One of the key questions the client asked was what percentage of his income should he be saving in order to have enough funds to retire. I told the client that many factors affect the answer. The one factor I want to focus on in this post is the effect of income above the payroll tax threshold. I created a scenario that showed a 27 year old person saving money for 40 years. That person then retires at 67 and only has social security and the assets they save to live on for the next 30 years.

The current social security threshold is \$127,200 in 2017. This means that for every dollar earned up to \$127,200 you are taxed at a rate of 6.2%. Your employer (or you if you are self-employed) also contributes 6.2% up to the payroll tax threshold. This also means that your benefit at retirement rises proportionally. If you make more than \$127,200 than you are not taxed on that amount but you also will not receive a larger benefit. In other words, the mandated government savings program stops at \$127,200 and you are now expected to make up the difference.

I did an analysis of the effect of different savings rates on producing successful outcomes. The goal was to produce an income that was 60% of the pre-retirement income. The income and expense were calculated using a 3.74% inflation rate (The rate used inside our eMoney planing tool). Assets were compounded at 7% pre-retirement and 5% post-retirement. Four different levels of income were compared: \$75,000, \$115,000, \$155,000 and \$195,000. The analysis uses a single social security income source and all figures are calculated on a pre-tax basis. The savings was calculated as a fixed percentage of annual income over a period of 40 years. At retirement, the annual income was recalculated to 60% of the prior years amount. This set a starting point for the retirement expense and this number was again compounded at the the 3.74% inflation rate.

The results showed that in order to avoid running out of money the person who who earned \$75,000 would need to save less than the person who earned \$195,000. This result is expected because one is above the \$127,200 threshold and the other is below. The savings rates for each income level to produce a successful result are:

\$75,000 – 7%      \$115,000 – 10%     \$155,000 – 12%    \$195,000 – 14%

The answer to the question is that the saving rate you must employ depends upon the amount of income you have above the social security payroll tax threshold all other factors held constant. In general, the higher your income, the greater your savings rate needs be. The actual number should be obtained by running your own plan and incorporating your individual asset allocations, savings schedules, types of accounts and tax situation.