By Stuart Ritter on November 12, 2012

I'm often asked many questions about saving for retirement. However, the most common concern is about having enough money to last throughout retirement. And it's a valid one.

First of all, let's establish the primary sources of income for those over age 65. According to the Social Security Administration, they are:

  • Wages for people who continue working,
  • Social Security benefits,
  • Money from retirement accounts, and
  • Money from taxable accounts.
Reading Between the Lines

The following chart breaks down the various sources of retirement income and the percentage of income today's "average" retiree receives from each. Let's look first at earnings, which supply 30%. Now I may be going out on a limb here, but I don't think many people have visions of working full time into their 80s. Though many retirees do continue to work in some capacity, it would be nice to be able to have that as a choice, not a necessity.

Sources of Income in Retirement—Average Retiree


Source: Social Security Administration, Income of the Aged Chartbook, 2010, page 16.

Our next source of projected cash is Social Security benefits, which provide nearly 40% of retirement income. On paper, it looks good. However, when I ask people if they think they'll receive the full Social Security benefit promised them under the current rules for their entire lifetime with no changes, I get a chagrined smile in response. While that slice will not disappear (even if no changes are made to the current system, Social Security will still be able to pay 75% of promised benefits well into the future), many people believe the Social Security slice could potentially be smaller for future retirees.

So if the wage source diminishes and eventually goes away and the Social Security segment may get smaller, what are the implications?

Step Up to the Plate

You have two choices: Either live on a smaller retirement pie (I doubt this will be tops on anyone's list) or save enough that the other two sources make up for what you'll need. And that's not as hard as it may seem-if you're willing to take steps to get on the right track.

Kick It Up to 15% NOW

The single most important action you can take right now is to ensure that you're saving enough. And that doesn't mean just enough to get a match from your employer's 401(k)-which is one of the biggest drivers of how much employees think they should save. It means saving at least 15% of your salary (a percentage that can include your employer's match). Saving enough trumps almost all other considerations-because if you're not putting enough away, everything else is secondary.

To illustrate my point, I used T. Rowe Price's Retirement Income Calculator to see how important contribution rate is: Someone who is 30 and is saving nothing—0%—for retirement obviously has no chance of his or her money lasting until age 95. If you save nothing, you'll have nothing.

What may surprise you is, if someone starts saving 3% of his or her salary, the chance of the money lasting to age 95 goes from 0% to…drum roll please…1%. That's right—on a 100-point scale, he or she has moved the needle from zero to one. At a 6% savings rate, he or she has a 15% chance. Even at 9%, it's only 37%. So saving "at least something" really doesn't get you much.

Saving 3% for retirement is like going to the gym for 6 minutes.
Can't Do It All Right Now?

If it is absolutely impossible to increase your retirement savings to 15% right now, raise it by 2 percentage points, then do that again every January. So if you’re at 6% now, increase it to 8% right now, then to 10% in January, then to 12% next year, and so on until you’re at 20%. Why 20%? Because it has to be higher than 15% to make up for the years you were below 15%.

Automate, Automate, Automate

To make it easier for you to stick with your savings plan, sign up for programs that do it automatically—in your 401(k) and/or IRA. That way you won't forget or fall behind your goal. It's an easy way to help ensure that you won't be one of those people living exclusively off Social Security. Bottom line, you can change your future—do it now.

Monte Carlo Simulation

Monte Carlo simulations model future uncertainty. In contrast to tools generating average outcomes, Monte Carlo analyses produce outcome ranges based on probability—thus incorporating future uncertainty.

Material Assumptions Include:

  • Underlying long-term rates of return for the asset classes are not directly based on historical returns. Rather, they represent assumptions that take into account, among other things, historical returns. They also include our estimates for reinvested dividends and capital gains.
  • These assumptions, as well as an assumed degree of fluctuation of returns around these long-term rates, are used to generate random monthly returns for each asset class over specified time periods.
  • The monthly returns are then used to generate 1,000 scenarios, representing a spectrum of possible return outcomes for the modeled asset classes. Analysis results are directly based on these scenarios.
  • Required minimum distributions (RMDs) are included. In the simulations, if the RMD is greater than the planned withdrawal, the excess amount is reinvested in a taxable account.

Material Limitations Include:

  • The analysis relies on return assumptions, combined with a return model that generates a wide range of possible return scenarios from these assumptions. Despite our best efforts, there is no certainty that the assumptions and the model will accurately predict asset class return ranges going forward. As a consequence, the results of the analysis should be viewed as approximations, and users should allow a margin for error and not place too much reliance on the apparent precision of the results. Users should also keep in mind that seemingly small changes in input parameters (the information the user provides to the tool, such as age or contribution amounts) may have a significant impact on results, and this (as well as mere passage of time) may lead to considerable variation in results for repeat users.
  • Extreme market movements may occur more often than in the model.
  • Some asset classes have relatively short histories. Actual long-term results for each asset class going forward may differ from our assumptions—with those for classes with limited histories potentially diverging more.
  • Market crises can cause asset classes to perform similarly, lowering the accuracy of our projected return assumptions, and diminishing the benefits of diversification (that is, of using many different asset classes) in ways not captured by the analysis. As a result, returns actually experienced by the investor may be more volatile than projected in our analysis.
  • The model assumes no month-to-month correlations among asset class returns ("correlation" is a measure of the degree in which returns are related or dependent upon each other). It does not reflect the average duration of "bull" and "bear" markets, which can be longer than those in the modeled scenarios.
  • Inflation is assumed to be constant, so variations are not reflected in our calculations
  • The analysis assumes a diversified portfolio which is rebalanced on a monthly basis. Not all asset classes are represented and other asset classes may be similar or superior to those used.
  • Taxes on withdrawals are not taken into account, nor are early withdrawal penalties.
  • The analysis models asset classes, not investment products. As a result, the actual experience of an investor in a given investment product (e.g., a mutual fund) may differ from the range of projections generated by the simulation, even if the broad asset allocation of the investment product is similar to the one being modeled. Possible reasons for divergence include, but are not limited to, active management by the manager of the investment product, or the costs, fees, and other expenses associated with the investment product. Active management for any particular investment product—the selection of a portfolio of individual securities that differs from the broad asset classes modeled in this analysis—can lead to the investment product having higher or lower returns than the range of projections in this analysis.

Modeling Assumptions:

  • The primary asset classes used for this analysis are stocks, bonds, and short-term bonds. An effectively diversified portfolio theoretically involves all investable asset classes including stocks, bonds, real estate, foreign investments, commodities, precious metals, currencies, and others. Since it is unlikely that investors will own all of these assets, we selected the ones we believed to be the most appropriate for long-term investors.
  • Results of the analysis are driven primarily by the assumed long-term, compound rates of return of each asset class in the scenarios. Our corresponding assumptions, all presented in excess of inflation, are as follows: for stocks, 4.90%, for bonds, 2.23% and for short-term bonds, 1.38%.
  • Investment expenses in the form of an expense ratio are subtracted from the return assumption as follows: for stocks 0.70%, for bonds, 0.60% and for short-term bonds, 0.55%. These expenses represent what we believe to be a reasonable approximation of investing in these asset classes through a professionally managed mutual fund or other pooled investment product.

Portfolio and Initial Withdrawal Amount:

  • The portfolio is either determined by the user or based on pre-constructed allocations that consider the user's current age and shift throughout the retirement horizon (as displayed in the graphic "Why should I consider this?" in the Asset Allocation section).
  • The initial withdrawal amount is assumed to be distributed in 12 monthly payments at the beginning of each month for the year; in each subsequent year, the amount withdrawn is adjusted to reflect a 3% annual rate of inflation.
  • The modeled asset class scenarios and withdrawal amounts may be calculated at, or result in, a Simulation Success Rate. Simulation Success Rate is a probability measure and represents the number of times our outcomes succeed (i.e. has at least $1 remaining in the portfolio at the end of retirement).

IMPORTANT: The projections or other information generated by the T. Rowe Price Retirement Income Calculator regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The simulations are based on assumptions. There can be no assurance that the projected or simulated results will be achieved or sustained. The charts present only a range of possible outcomes. Actual results will vary with each use and over time, and such results may be better or worse than the simulated scenarios. Clients should be aware that the potential for loss (or gain) may be greater than demonstrated in the simulations. The Retirement Income Calculator won the 2009 Mutual Fund Education Alliance Star Award for Best Retail Online Innovation. The results are not predictions, but they should be viewed as reasonable estimates. Source: T. Rowe Price Associates, Inc.