Should I be saving 20% including the employer match?

[PhysicianOnFIRE]

drjcline wrote:

Do you consider contributions to 529s (HSAs if you have them), and in my situation, payments on commercial real estate loans “investing?” Essentially, should these be included in my 20% or do these fall into another category and I need to increase my savings elsewhere?

Click to expand...

529s, no. That money is earmarked for your children's education, not your retirement. Good for you for doing it, though.

HSA, maybe. Most likely, you'll be spending it all on healthcare at some point. Some of that will probably be in retirement.

Payment on commercial real estate, yes. That's an investment, not spending, so it counts.

I'd focus less on the number of the savings rate and more on intentional spending. Try to get good value from the dollars you spend, and invest the rest. You'll likely find your savings rate exceed 20% if you do, regardless of how you calculate it.

Cheers!

-PoF

[RogueDadMD]

PoF -- the 529 isn't part of the retirement saving 20% but it's money that doesn't need to be replaced in retirement so it shouldn't be counted in the "% of money I need to replace in retiremen"

[ENT Doc]

I would separate a few things here.  Your savings and savings rate is different from investing.  Investing is what occurs after you have the saving.  Also, your savings and savings rates are derived from an income statement, which is periodic.  Your transaction with the loan created two balance sheet items, which is a spot in time assessment.  When you took out the loan that $X went into your liabilities and your assets.  Over a period of time (say a year) your income statement will be hit by additional income (gross) from whatever benefit you derive from the commercial real estate.  On the flip side, your spending will now include the loan payments and any additional expenses such as taxes, etc. owed on that property.  What you net from that commercial real estate transaction will be included in your savings (numerator) and the gross income will be included in your overall denominator.  What you choose to do with your savings is "investing".  I would definitely include the income statement items derived from your commercial real estate in your savings rate calculation.  I would also include your HSA money in the numerator of your savings rate calculation.  As previously stated in an earlier post, I do two savings rates - one with and one without 529.  All that matters to me and my wife from a retirement standpoint is the without 529 assessment.  The saving rate goal of 20% has to do with retirement savings, so it makes sense to not include the 529.  But since the 529 money is still savings and I care about assessing our relative frugality over time I look at the with 529 saving rate too.  In order to compare my 2017 self to my 2030 self I use:

((Total Savings/After-Tax Income) / After-Tax Income) x 100,000

The 100,000 is simply to bring the ratio to a reasonable decimal place.
Total savings = taxable, pre-tax retirement, HSAs, employer contributions, 529s, principal payments, etc.
After-Tax Income = Gross Income – (FICA + State + Federal Taxes)

[Donnie]

ENT Doc wrote:

I would separate a few things here.  Your savings and savings rate is different from investing.  Investing is what occurs after you have the saving.  Also, your savings and savings rates are derived from an income statement, which is periodic.  Your transaction with the loan created two balance sheet items, which is a spot in time assessment.  When you took out the loan that $X went into your liabilities and your assets.  Over a period of time (say a year) your income statement will be hit by additional income (gross) from whatever benefit you derive from the commercial real estate.  On the flip side, your spending will now include the loan payments and any additional expenses such as taxes, etc. owed on that property.  What you net from that commercial real estate transaction will be included in your savings (numerator) and the gross income will be included in your overall denominator.  What you choose to do with your savings is “investing”.  I would definitely include the income statement items derived from your commercial real estate in your savings rate calculation.  I would also include your HSA money in the numerator of your savings rate calculation.  As previously stated in an earlier post, I do two savings rates – one with and one without 529.  All that matters to me and my wife from a retirement standpoint is the without 529 assessment.  The saving rate goal of 20% has to do with retirement savings, so it makes sense to not include the 529.  But since the 529 money is still savings and I care about assessing our relative frugality over time I look at the with 529 saving rate too.  In order to compare my 2017 self to my 2030 self I use:

((Total Savings/After-Tax Income) / After-Tax Income) x 100,000

The 100,000 is simply to bring the ratio to a reasonable decimal place.
Total savings = taxable, pre-tax retirement, HSAs, employer contributions, 529s, principal payments, etc.
After-Tax Income = Gross Income – (FICA + State + Federal Taxes)

Click to expand...

I think the above may be overthinking things. I would not include RE investment income or expenses in a savings rate.  If the investment is large, that will distort your savings rate.  I also don't include dividends in my savings rate either.

I have never seen a formula like what is in bold, and can't figure out what it is supposed to be.  Total savings / After tax income ^2 x 100,000?

Maybe you just meant total savings / after tax income x100,000, but I don't get why you would multiply by 100,000.  How many decimals do you need?

[VagabondMD]

PhysicianOnFIRE wrote:

drjcline wrote:

Do you consider contributions to 529s (HSAs if you have them), and in my situation, payments on commercial real estate loans “investing?” Essentially, should these be included in my 20% or do these fall into another category and I need to increase my savings elsewhere? 

Click to expand…

529s, no. That money is earmarked for your children’s education, not your retirement. Good for you for doing it, though.

HSA, maybe. Most likely, you’ll be spending it all on healthcare at some point. Some of that will probably be in retirement.

Payment on commercial real estate, yes. That’s an investment, not spending, so it counts.

I’d focus less on the number of the savings rate and more on intentional spending. Try to get good value from the dollars you spend, and invest the rest. You’ll likely find your savings rate exceed 20% if you do, regardless of how you calculate it.

Cheers!

-PoF

Click to expand...

I agree with all of this. I think some are fixated on calculating the savings rate, when in the end, whether it is 19% not including 529, employer match, and HSA or 25% including all of the above and the kitchen sink is not the point.

The point is to keep your spending rate as low as you comfortably can for as long as you comfortably can and make sure that your savings match your financial goals (be they retirement, college, house down payment, NFL franchise, or whatever).

[The White Coat Investor]

har02052 wrote:

So when I look at my savings rate, I am trying to get above 20% of my gross income. Should this amount include whatever my employer puts in as a match? Or should I try to get 20% myself and consider the match as a “bonus”. My employer match and contributions ends up being about 8% or so. Which means I only have to put in about 12% to total 20%.  My thought is that I will try to get up to 20% myself and then the employer contribution is just extra.

Click to expand...

I view the employee 401(k) match as part of your salary, so I would include it in both the numerator and the denominator when calculating your savings rate.

[ENT Doc]

Donnie wrote:

ENT Doc wrote:

I would separate a few things here.  Your savings and savings rate is different from investing.  Investing is what occurs after you have the saving.  Also, your savings and savings rates are derived from an income statement, which is periodic.  Your transaction with the loan created two balance sheet items, which is a spot in time assessment.  When you took out the loan that $X went into your liabilities and your assets.  Over a period of time (say a year) your income statement will be hit by additional income (gross) from whatever benefit you derive from the commercial real estate.  On the flip side, your spending will now include the loan payments and any additional expenses such as taxes, etc. owed on that property.  What you net from that commercial real estate transaction will be included in your savings (numerator) and the gross income will be included in your overall denominator.  What you choose to do with your savings is “investing”.  I would definitely include the income statement items derived from your commercial real estate in your savings rate calculation.  I would also include your HSA money in the numerator of your savings rate calculation.  As previously stated in an earlier post, I do two savings rates – one with and one without 529.  All that matters to me and my wife from a retirement standpoint is the without 529 assessment.  The saving rate goal of 20% has to do with retirement savings, so it makes sense to not include the 529.  But since the 529 money is still savings and I care about assessing our relative frugality over time I look at the with 529 saving rate too.  In order to compare my 2017 self to my 2030 self I use:

((Total Savings/After-Tax Income) / After-Tax Income) x 100,000

The 100,000 is simply to bring the ratio to a reasonable decimal place.
Total savings = taxable, pre-tax retirement, HSAs, employer contributions, 529s, principal payments, etc.
After-Tax Income = Gross Income – (FICA + State + Federal Taxes)

Click to expand…

I think the above may be overthinking things. I would not include RE investment income or expenses in a savings rate.  If the investment is large, that will distort your savings rate.  I also don’t include dividends in my savings rate either.

I have never seen a formula like what is in bold, and can’t figure out what it is supposed to be.  Total savings / After tax income ^2 x 100,000?

Maybe you just meant total savings / after tax income x100,000, but I don’t get why you would multiply by 100,000.  How many decimals do you need?

Click to expand...

You bring up good points.  I think there is a valid argument to be made for not including passive income in the savings rate calculation, whether it be RE investment income or dividends or whatever.  It gets a little blurry though, because what if your business is in real estate investing, or what if 1/2 your time is spent doing that, or 75% of the time.  When do you draw the line at calling it illegitimate?  I don't know.

Regarding the formula, the 100,000 number was arbitrary and is described above to just bring things to a reasonable decimal place.  But the purpose of the formula is to create as close to apples to apples comparison when it comes to a person comparing their saving rate either over time when entering different tax brackets or comparing to others (if desired).  The point was to try to show a savings rate given one's ability to save.  To just use total savings/after-tax income would bias the results heavily towards the high-income earner who has the same spending level as a lower income earner.  However, in looking at the calculation further, the results of the formula I described tend to bias results towards the lower after-tax income.  I don't know what the right answer is, but as I stated in the thread I created on this a month or two ago I don't think savings rates matter one iota.  They are a derivation of a given goal, not the goal itself (or at least that should be the case in theory).  Ideally, someone should be saying "I need $X by 65 in order to retire at a 3.5% withdrawal rate (the goal).  Given my asset allocation and expected returns of Y% given that allocation I need to put away Z per month/year in order to achieve that goal".  But for those who want to care about savings rate comparisons or achieving a given savings rate and comparing it over time there needs to be a way to control for one's potential to save in order to have a meaningful comparison.

[hightower]

har02052 wrote:

Sorry, I am getting ahead of myself. I finish in a few months and just looking at financials and how much to set my 401k, 403b, 457, 529, and other contributions at when I do start getting those paychecks. If the money disappears from my paycheck before I ever see it, there is no way for me to start to grown into my income.

 

Click to expand...

Yes, it's important to set a certain amount aside automatically each paycheck.  The 401k contributions are a must as it will save you a lot in taxes and gain you the full match.  I personally don't contribute to a 403b, 457, or 529 so I can't comment there.

Another important thing to do is calculate exactly how much you need each month to pay the bills and cover all of your expenses and plan on saving everything else. Whether it's paying off debt or putting money into a taxable, subtract what you need and contribute the rest every time you get paid.

 

[jsr52]

I agree picking a random number to save is a bit backwards. If you want to get real mathematical you should first figure out the monthly income you want in retirement, factoring in social security. Then you can get a sense of what the total value of your retirement should be as you approach retirement, only then can you work backwards and figure out what your saving percentage should be for retirement. I'm sure if most high-income earners only saved 10% of their income they would have plenty to live off of in retirement if they lived rather frugally, compared to those who save 40-50%, they will probably wind up passing on a nice inheritance.

Personally I save 15% (I'm a fellow so I don't have a match), since 15 is all I can afford right now, but my savings rate automatically will increase by 1% every three months or so.

[RogueDadMD]

jsr52 wrote:

I agree picking a random number to save is a bit backwards.

Click to expand...

Having a rough goal of a savings rate regardless of specific financials is not backwards -- it's a great guidepost.

You can put it into buckets.  A savings rate of 0-10% and barring some external funding or ability to dramatically reduce your lifestyle, it will be difficult to retire before age 65.  11-30% and you can probably retire 55-65.  30+% and you can retire even earlier.

For someone who doesn't know exactly how much they need or when they want to retire, using that as a starting point (feel free to adjust the buckets) this is can tell you if you're way off target.

[DMFA]

I know a lot of those who have posted know and understand it, but I just want everyone reading the thread to understand where this idea of a savings rate, and the 20% number, comes from.  The "20% savings rate" is intended to be the following:

• a rule-of-thumb


• broadly generalizable


• understood by financial novices

Therefore its limitations are fairly obvious in that it isn't universally applicable and can be rendered semantically irrelevant if an individual breaks it down into nuts and bolts.

The entire purpose is to estimate your retirement income in relation to your current income.  Clearly, if you are not yet at maximal income for your career, then it will not be appropriately representative.  Therefore, the only things that should count toward your saving rate are things that are being saved/invested for the purpose of generating retirement income, and your retirement income is likewise only being represented in terms of your current income.  If those aren't commensurate with your current situation, then it's going to be a garbage number.  If that's the case, then you'd need to figure out what you think your future retirement income would need to be, divide that by your planned withdrawal rate (4% is commonly thrown out, so you'd divide by 0.04, or multiply by 25), and shoot for that number; for example, if you want $100,000/year, you'd want $2,500,000 specifically for retirement income.

Also, there is often a question as to whether to use gross or net to figure it.  I posit that gross should be used since you can factor in the reduction of your tax bracket into the retirement income side of the equation.  It's arguable that net is what matters since some of your investment will be tax-free on withdrawal (Roth, LTCGs if in 15% bracket), but again that adds a bit of complication to it.  For people who will be able to plan their future finances to that degree of detail, this whole thing is a moot point anyway.

While it's true that X dollars here can still equal X dollars there (i.e. "money is fungible"), the following things should NOT be included in your saving rate, since while they do go toward your net worth, they are not used to generate retirement income and therefore won't fit the equation on which the "savings rate" is based:

• 529 college savings accounts


• Student loan or other debt payments


• Mortgage payments


• Any investment holding not planned for being used as retirement income

Also, things like HSAs could go either way.  Lots of us here plan to use the HSA as another retirement account, so I'd include it.  Also the oft-mentioned profit-sharing contribution for employees counts both for savings and income, hence the "numerator and denominator" argument previously mentioned.  If you plan on investing in real estate solely for the purpose of creating retirement income, that's a slightly tougher one to figure, and you'd have to assume future income and expenses, or at least sale value to add to the rest of your nest egg if you so choose.

If you're planning for when you're out of debt, then you can fudge your numbers to count them since you'll get to it eventually, but that moves the time goalposts (which I'll get to in a bit) and just be aware that you're still fudging your numbers to make them look better.

Now to get to the 20% figure.  This is basic financial math using the future value concept, expressed in Excel as =FV(rate,nper,-pmt,pv,type).  To reverse-engineer this, you're basically trying to figure out the payment portion using the annuity formula in Excel =-PMT(rate,nper,pv,fv,type) to achieve a specific percentage of pre-retirement income.  To simplify, we'll just infer the following:

• you'll save 20% of gross income annually, specifically for retirement income (p = -0.2; it's saving, so it's a "negative payment" in Excel)


• you'll save that amount for 30 years (n = 30)


• you'll gain 5% on those investments annually (r = 0.05)


• you don't have anything now (PV = 0)


• you'll have a safe withdrawal rate of 4% (w = 0.04)

So, sigma p([1+r]^n) when n = {1,2,3...30}, or =FV(0.05,30,-0.2,0,1), is 13.95, meaning you'll have in retirement savings nearly 14x your income.  Multiplied by your SWR of 4%, that comes out to 0.56, or 56% of your pre-retirement income in retirement.  Why is 56% of pre-retirement income OK?  That's a huge pay cut, right?  Well...

• You won't need retirement savings anymore (-20%)


• You'll be in a lower tax bracket, and some of your retirement income (e.g. Roth) will be tax free (-10-15% or so)


• You [ideally] won't have a mortgage payment anymore


• You won't need life or disability insurance anymore since you won't have any earned income to replace


• You'll [hopefully] have social security


• You can still earn little bits of money every now and then if you really feel like it and you get bored

So based on that math alone, 56% of pre-retirement income *should* be all you'd need to continue living the exact same life you've been living.

Now, obviously, this is based on you working for 30 years, having compound annual growth of 5%, and withdrawing 4% a year.  All those variables are, well...variable.  You might want to work for fewer years and hence need to save more, but then you'll be retired for longer, and might need a lower withdrawal rate.  You might really kill it in the market and have better gains, or inflation might eat away your gains (none of this is really indexed for inflation, other than if it's reflected in your holdings' gains and in the amount you saved each year with your inflation-adjusted income) and you need to re-adjust.  That's lots of moving targets.

So if I want to have that same percentage of income (56%) of my current income in retirement but only work for 20 years, and as such need a lower safe withdrawal rate (3%), but think I'll earn 6% CAGR over time, then I'd need to save =-PMT(6%,20,0,0.56/0.03,1) = 0.48, or 48%.  This is commensurate with PoF's "live on half" mantra, probably not for this exact reason, but it sure does fit nicely with it.

So I hope this both answers some questions and creates more, because that's what understanding is really about...why your "savings rate" matters, and why it doesn't.  Yes, you should try to save 20% of your gross income each because it's a very easy rule of thumb to follow and *should* put you on the right track, but like all broadly generalized rules-of-thumb, it has its limitations.

[Miss Bonnie MD]

I don't count employer match + contribution  - but I do put the match/contribution in both numerator & denominator when calculating my savings rate - based on GROSS income.  So it is counted but cancels itself out.

 

I also count extra student loan payments in this "savings rate", not the ones I have to make anyway. I don't live by this savings rate, but I find it useful to see where we are. We have a plan of course.

[Miss Bonnie MD]

har02052 wrote:

Sorry, I am getting ahead of myself. I finish in a few months and just looking at financials and how much to set my 401k, 403b, 457, 529, and other contributions at when I do start getting those paychecks. If the money disappears from my paycheck before I ever see it, there is no way for me to start to grown into my income.

 

Click to expand...

I did this from the get go - and I have NOT missed it. This is a great idea. You learn to live on what's left.

[Donnie]

DMFA wrote:

I know a lot of those who have posted know and understand it, but I just want everyone reading the thread to understand where this idea of a savings rate, and the 20% number, comes from.  The “20% savings rate” is intended to be the following:

• a rule-of-thumb


• broadly generalizable


• understood by financial novices

Therefore its limitations are fairly obvious in that it isn’t universally applicable and can be rendered semantically irrelevant if an individual breaks it down into nuts and bolts.

The entire purpose is to estimate your retirement income in relation to your current income.  Clearly, if you are not yet at maximal income for your career, then it will not be appropriately representative.  Therefore, the only things that should count toward your saving rate are things that are being saved/invested for the purpose of generating retirement income, and your retirement income is likewise only being represented in terms of your current income.  If those aren’t commensurate with your current situation, then it’s going to be a garbage number.  If that’s the case, then you’d need to figure out what you think your future retirement income would need to be, divide that by your planned withdrawal rate (4% is commonly thrown out, so you’d divide by 0.04, or multiply by 25), and shoot for that number; for example, if you want $100,000/year, you’d want $2,500,000 specifically for retirement income.

Also, there is often a question as to whether to use gross or net to figure it.  I posit that gross should be used since you can factor in the reduction of your tax bracket into the retirement income side of the equation.  It’s arguable that net is what matters since some of your investment will be tax-free on withdrawal (Roth, LTCGs if in 15% bracket), but again that adds a bit of complication to it.  For people who will be able to plan their future finances to that degree of detail, this whole thing is a moot point anyway.

While it’s true that X dollars here can still equal X dollars there (i.e. “money is fungible”), the following things should NOT be included in your saving rate, since while they do go toward your net worth, they are not used to generate retirement income and therefore won’t fit the equation on which the “savings rate” is based:

• 529 college savings accounts


• Student loan or other debt payments


• Mortgage payments


• Any investment holding not planned for being used as retirement income

Also, things like HSAs could go either way.  Lots of us here plan to use the HSA as another retirement account, so I’d include it.  Also the oft-mentioned profit-sharing contribution for employees counts both for savings and income, hence the “numerator and denominator” argument previously mentioned.  If you plan on investing in real estate solely for the purpose of creating retirement income, that’s a slightly tougher one to figure, and you’d have to assume future income and expenses, or at least sale value to add to the rest of your nest egg if you so choose.

If you’re planning for when you’re out of debt, then you can fudge your numbers to count them since you’ll get to it eventually, but that moves the time goalposts (which I’ll get to in a bit) and just be aware that you’re still fudging your numbers to make them look better.

Now to get to the 20% figure.  This is basic financial math using the future value concept, expressed in Excel as =FV(rate,nper,-pmt,pv,type).  To reverse-engineer this, you’re basically trying to figure out the payment portion using the annuity formula in Excel =-PMT(rate,nper,pv,fv,type) to achieve a specific percentage of pre-retirement income.  To simplify, we’ll just infer the following:

• you’ll save 20% of gross income annually, specifically for retirement income (p = -0.2; it’s saving, so it’s a “negative payment” in Excel)


• you’ll save that amount for 30 years (n = 30)


• you’ll gain 5% on those investments annually (r = 0.05)


• you don’t have anything now (PV = 0)


• you’ll have a safe withdrawal rate of 4% (w = 0.04)

So, sigma p([1+r]^n) when n = {1,2,3…30}, or =FV(0.05,30,-0.2,0,1), is 13.95, meaning you’ll have in retirement savings nearly 14x your income.  Multiplied by your SWR of 4%, that comes out to 0.56, or 56% of your pre-retirement income in retirement.  Why is 56% of pre-retirement income OK?  That’s a huge pay cut, right?  Well…

• You won’t need retirement savings anymore (-20%)


• You’ll be in a lower tax bracket, and some of your retirement income (e.g. Roth) will be tax free (-10-15% or so)


• You [ideally] won’t have a mortgage payment anymore


• You won’t need life or disability insurance anymore since you won’t have any earned income to replace


• You’ll [hopefully] have social security


• You can still earn little bits of money every now and then if you really feel like it and you get bored

So based on that math alone, 56% of pre-retirement income *should* be all you’d need to continue living the exact same life you’ve been living.

Now, obviously, this is based on you working for 30 years, having compound annual growth of 5%, and withdrawing 4% a year.  All those variables are, well…variable.  You might want to work for fewer years and hence need to save more, but then you’ll be retired for longer, and might need a lower withdrawal rate.  You might really kill it in the market and have better gains, or inflation might eat away your gains (none of this is really indexed for inflation, other than if it’s reflected in your holdings’ gains and in the amount you saved each year with your inflation-adjusted income) and you need to re-adjust.  That’s lots of moving targets.

So if I want to have that same percentage of income (56%) of my current income in retirement but only work for 20 years, and as such need a lower safe withdrawal rate (3%), but think I’ll earn 6% CAGR over time, then I’d need to save =-PMT(6%,20,0,0.56/0.03,1) = 0.48, or 48%.  This is commensurate with PoF’s “live on half” mantra, probably not for this exact reason, but it sure does fit nicely with it.

So I hope this both answers some questions and creates more, because that’s what understanding is really about…why your “savings rate” matters, and why it doesn’t.  Yes, you should try to save 20% of your gross income each because it’s a very easy rule of thumb to follow and *should* put you on the right track, but like all broadly generalized rules-of-thumb, it has its limitations.

Click to expand...

Thanks for taking the time to write the detailed post.  I agree that rules of thumb can be helpful.  Rules of thumb are generally designed to keep the general population out of trouble, and that's a good thing.  This particular rule of thumb is championed by Elizabeth Warren, so I am skeptical about it being optimal or even applicable to a high earner.  The justification you provided for the 20% rule is reasonable, although seemingly reverse engineered.  I think the true origins are a bit more simplistic (i.e. 20% sounds good, 80/20 rule, etc.) and typically includes all savings (emergency account, debt pay down, etc.).

In my view a savings rate based on income runs counter to how I think about my own retirement need.  I am not trying to replace an income, I am trying to replace a spending level.  Therefore looking at a savings rate using my current income does not provide any quantitative insight into how I am performing relative to my savings goal.  For example, how bad is it if I save 18% of income rather than 20%?  I don't really know.  If I know i need to save $30k per year and I save 80% of that number, or 120% of that number, I know what that means.  Starting at a savings rate of income also requires a number of squishy assumptions to convert that savings rate into a spending level per year.

 

I would look at it this way, you need to save 36 cents/year for every dollar/year you want to spend in retirement using the 4% rule and a 5% investment return over 30 years.  If you want to spend $100k per year in retirement, you need to save $36k per year.  If you make $200k per year, that's an 18% savings rate if you want to look at it that way.  The $36k per year would include only retirement savings and include matches.  You can include retirement matches in the denominator or not, but you just have to be consistent.  You can then compare your actual annual retirement savings to $36k and you know how you are doing every year without further thought.