A person’s income need in retirement varies from person-to-person. There is no one solution that can fulfill everyone’s retirement goals. Most 401(k) participants understand that their goal in participating in an employer sponsored plan is to accumulate a balance large enough that will replace most of their working income, thus providing the opportunity for someone to walk into work one day and say, “ I quit “. (We’d hope a participant would not use those terms exactly, and instead say something along the lines of, “I am retiring “ or “I’m headed to Boca Raton, keep in touch!”.
Most plan participants need guidance to set realistic goals regarding how much they need to save in order to retire.
How much income is needed to save for retirement
In order to be able to walk into work one day and say “I’m retiring” a person might need between 70% and 80% of their working income in retirement. A full 100% of working income isn’t necessary because income taxes may be less in retirement–FICA deductions end and taxable income usually decreases.
Use the income replacement ratio calculation
One way to help set realistic savings goals while participating in an employer sponsored plan is to use the “income replacement ratio calculation.” The income replacement ratio helps determine how much of an employee’s working income will be needed in retirement. For example, if someone earns a $50,000 annual income before retirement and he or she retires and receives $35,000 of their annual income, which is composed of Social Security and other retirement income, this person’s replacement ratio is 70 percent. To find this ratio, divide the retirement income by the pre-retirement income and multiple by 100.
Retirement Income ÷ Pre-Retirement Income X 100 = Income Replacement Ratio
This calculation can be used as a benchmark for a participant to help track how they are doing in saving towards their goal.