The More We Make, the Harder it Becomes to Retire

In the final quarter of the year, I had the opportunity to run retirement plans on quite a few 401(k) plan participants. Whenever possible, I enjoy sitting one-on-one with employees to help them understand and formulate a retirement scenario.

One would think that the less you make the harder it is to retire, but I have found just the opposite to be true. It can become harder to retire when our income is greater because Social Security replaces less of our income as a percentage once you start collecting benefits. (For related reading, see: 5 Ways Your Retirement Plan Can Fail.)

Social Security Basics

Let's review how Social Security works:

  1. 6.2% is deducted from your pay, matched by your employer, and sent to the government to fund Social Security. That's 12.4% of your wages in total, up to a maximum wage of $118,500 after which no further Social Security tax is deducted.
  2. Your Social Security benefit at retirement is calculated by taking your lifetime earnings (up to each year's maximum allowable earnings), indexing for inflation and converting to a monthly amount called your average indexed monthly earnings (AIME).
  3. Your AIME is then reduced by certain amounts using the following progressive formula:
  • 90% of the first $856
  • 32% from $857 to $5,157
  • 15% over $5,157

Examples of Monthly Social Security Payments

I know it sounds complicated, but it's the government, what do you expect? Here are three examples to help demonstrate my point:

  1. Bill is age 35, makes $48,000 per year, and plans to retire at age 67. My software projects in today's dollars he will receive about $2,430 per month in Social Security. That's roughly 60% of his current income.
  2. Debbie, also age 35, makes $125,000 per year. If she retires at 67, her Social Security is projected to be $4,043 per month, or 40% of her current income. 
  3. Gerald is a high wage earner, making around $300,000 per year, so he can count on only 16% of his income being replaced by Social Security in retirement, or $4,117 per month in today's dollars. (For related reading, see: How Much Social Security Will You Get?)

In each case, retirement savings will be needed to augment Social Security for a comfortable retirement. As a general rule, we want our retirement income to be at least 85% of our pre-retirement wages. Let's assume our examples are just now, at age 35, getting started on retirement savings. How much of their current income will they need to save?

  1. Bill will need to contribute at least $355 per month towards his retirement savings plan to meet his goal. That's 9% of his pay and fairly close to the 10% general rule for savings most planners recommend. 
  2. Debbie needs to save at least $1,760 of her income, which is a hefty 17% of pay. That's much higher from a percentage point than most would expect.
  3. Gerald has a huge gap to fill if he wants to live in a similar fashion to his current lifestyle when retired. My software calculates his required monthly contributions towards retirement will need to be at least $6,268 per month, or one-fourth of his paycheck. Ouch!

I have been running retirement plans for over twenty years, and the results still surprise me. With full knowledge, we can adjust our spending to support higher retirement deferral rates as our income increases, but this is rarely the case. Most of us use higher wages to increase our standard of living, but fail to take the necessary steps required to sustain that higher standard in retirement.

The best thing we can do is run a retirement scenario. If you are unsure about how much to save towards retirement, you need find out. Schedule some time with a financial planner and it will be well worth it. (For more from this author, see: 5 Questions You Need to Ask Before Investing.)