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Why the 10% Savings Rule Doesn't Work for Everyone

Many people may have heard they need to be saving 10% of their income for retirement, but this strategy doesn't actually work for everyone. If you begin digging around the internet for ideas about personal finance, you’ll find a lot of principles people say are good to follow. These strategies have been created over the years to give people quick reference points when considering each area of their financial lives.

The problem is when you paint with broad brush strokes, you miss a lot of the nuances of each individual. Let's examine what happens if someone follows the 10% income saving rule.

Saving 10% if Your Income for Retirement

The basis of this idea is pretty straightforward: Set aside 10% of each paycheck into a qualified retirement account. This could be a 401(k), IRA, 403(b), etc. The idea is if you are saving this amount on a regular basis, you should be in a good place by the time retirement rolls around. For us to know if the 10% rule is worth following, let’s look at what it actually takes to retire.

For starters, research shows you should be able to live off of about 4% of your retirement account each year without running out of money. Some argue that it’s 3%, others 5%, but we’ll just use 4% as a starting point. The average American family makes just over $48,000 each year. So, based on the average family income, the 4% rule, and your desired replacement income, this family will need $900,000 in their retirement account when they retire.

Can saving 10% of your income get you to $900,000 by the time you retire? The quick answer is yes, it could. But there are a lot of variables at play.

Factors That Influence Retirement Savings

To get the most out of your retirement savings plan, you need to begin at an early age. You also need to get a decent rate of return on your investment portfolio. If the above family put 10% of their income into a retirement account beginning at age 25, received a 7% return and retired at 65, they would have a nest egg of just over $950,000.

But not everyone can began saving for retirement at age 25. What happens if you begin saving at 30, or even 35? If you begin saving at age 30, you’d only end up with about $664,000. And if you start at 35, you’d have $453,000. If you still wanted to hit that $900,000 goal, but only started saving 10% at age 35, you’d need an average investment return of 10.7%, which is not very likely.

Being more realistic about investment returns and assuming something closer to 7% to 8%, if you begin saving at 35, you’d actually need to contribute around 16.5% to 19.8% of your income each year. That’s up to as much as double what the 10% income saving rule tells you to aim for. Clearly, this strategy doesn't work for everyone.

Your total dollar earnings are not the issue, it’s the percentage of savings where people get into trouble. Even if you are making over $100,000 each year and saving 10%, you are still dealing with the same assumptions, albeit at higher dollar amounts.

The 10% Rule Is a Good Starting Point

The 10% rule is a good place to start if you aren’t saving much to begin with. As of October 2017, the average U.S. personal savings rate was just 3.2%, so getting up to 10% would be a step in the right direction.

But the 10% rule only works if you start saving at a very early age, and if you get a decent investment return along the way. You will be better off if you do your own calculations and figure out what your personal savings rate needs to be.