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What's the right retirement savings target for millennials?

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A new study by NerdWallet reveals that 22 percent of pay could be the new retirement savings goal for millennials. If you add this to what it’s costing them to repay student debt, higher housing costs and an uncertain job market, no wonder so many millennials may feel doomed financially.

But will they really need to save 22 percent of pay for retirement? If you’re a millennial, it depends on how optimistic or pessimistic you are about a number of factors, such as your assumed retirement age, the return you achieve on your savings, how much income you need in retirement and how much you’ll get from Social Security. 

The fact is, any calculation of a retirement savings goal makes a number of assumptions about the future, and the farther away that future is, the more likely it is that the assumptions will turn out to be wrong.

Millennials are at the age where any calculation of a retirement savings goal is, at best, a guestimate and more often is simply a shot in the dark.

The NerdWallet analysis resulting in the 22 percent savings target assumes a 25-year-old currently making the median wage of $40,000 per year will retire at age 67 and will need to replace 80 percent of her income for a comfortable retirement. 

These last two assumptions may or may not be too pessimistic, depending on your goals and circumstances. For instance, many millennials plan to work in their retirement years and retire later than age 67 (although it remains to be seen if they’ll be able to find work). And many retirees are quite happy living on reduced incomes in exchange for their retirement freedom.

The NerdWallet analysis resulting in the 22 percent savings assumes annual stock market returns will fall to 5 percent per year from the historical average of 7 percent. NerdWallet also calculates that the 22 percent target will drop to 13 percent of pay if stock returns are 7 percent per year.

Most important, its calculations assume you’ll get nothing from Social Security, a position that may prove to be way too pessimistic

All told, NerdWallet’s 22 percent figure is based on a number of assumptions that lean toward pessimism. If you feel the same way and you have the ability to save 22 percent of pay (or even 13 percent), perhaps these high savings targets will work for you. And if your life turns out better than you expect, perhaps you can retire earlier than planned.

A more optimistic perspective

The Boston College Center for Retirement (CRR) also recently provided retirement savings guidelines that can apply to millennials. It calculated guidelines for a number of situations depending on your earnings level, the age you started saving for retirement and the age you expect to retire. For example, if you start saving at age 25 and are a middle-income earner, these savings targets are most applicable to your situation, according to CRR:

  • To retire at age 62: Save 15 percent of pay
  • To retire at age 65: Save 10 percent of pay
  • To retire at age 67: Save 7 percent of pay
  • To retire at age 70: Save 4 percent of pay

To compare these numbers directly to the NerdWallet analysis, the CRR savings guideline for a 25-year-old who retires at age 67 is 7 percent of pay, a far cry from 22 percent or even 13 percent.

These CRR’s assumptions are more optimistic than NerdWallet’s:

  • Middle-income earners will need a retirement income of 71 percent of their pay in retirement
  • They’ll receive about 41 percent of their pay from Social Security and 4 percent from a reverse mortgage on their home.
  • Savings will earn a real rate of return of 4 percent per year. When you factor in inflation, you’ll get closer to the historical 7 percent return mentioned in the NerdWallet analysis.
  • Retirees will annuitize their retirement savings, which usually produces the highest amount of retirement income compared to other methods of generating retirement income from savings. (By the way, most retirees don’t currently annuitize very much, if any, of their retirement savings.) 

All told, the CRR assumptions may lean toward being somewhat optimistic.

As you can see, a lot of factors go into calculating retirement savings targets. If you don’t have time to do your own calculation, your best bet would be to pick a reasonable savings target that fits your outlook for the future, then be prepared to fine-tune your calculations when you reach your 40s or early 50s. 

If you have the time and inclination, you can prepare your own calculations using one of the many retirement savings calculators you can find online or with your 401(k) plan administrator.

A recent study by Transamerica reports that the median savings levels for millennials is currently 7 percent of pay, not counting employer matching contributions, which should be counted toward meeting savings targets. For many millennials, contributing the maximum that their employer matches may result in total savings amounts, including the employer match, that fall between the NerdWallet and CRR analyses and might represent a reasonable and realistic compromise.

If you’re now in your 20s or 30s, you can do lots of things to get a good start on life -- build your career, nurture a social network, take care of your health and, for some people, find a mate, start a family and build your nest. These goals can be a tall order, and if while juggling with them you’re still able to set aside as much as possible for retirement, you’re doing great.

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