Generation Y is facing a retirement nightmare.

The national personal saving rate is less than 5%, according to the Federal Reserve Bank of St. Louis — and that’s just not enough. Putting away even 5% of income each year in hopes of building a sufficient retirement portfolio won’t get the job done, even if people start saving for retirement as early as 30.

Let’s run the numbers, taking as an example a 30-year-old who currently makes $40,000; we’ll assume that salary will grow at 4% each year until retirement. If she saves 5% of her income each year, and her investment portfolio has a 9% annualized return before retirement, she will have just under $1.3 million (in nominal terms) saved by age 70.

Building up a $1.3 million nest egg sounds pretty good. Yet assuming 4% inflation during her 40-year working career, she would need to withdraw $120,026 in the first year of her retirement just to cover half of her needed annual income.

Moreover, the annual withdrawals from her retirement will need to increase by 4% each year to combat inflation during her retirement years. By age 80, she will be out of money. (The assumptions here include a 7% average annualized portfolio return during retirement, a 20% annual tax bite and a 50% replacement ratio — meaning that the first withdrawal from the investment portfolio is 50% of working income during the last year of work.)

Mind you, this is one of the better-case scenarios. See the “Building a Nest Egg” chart below for the more challenging ones.

If the same person were to wait until age 40 to start saving for retirement — and we make all the same assumptions, putting her annual salary by that point at $59,210 — her retirement portfolio would be empty by age 75.

If her retirement savings plan doesn’t get started until age 50, when her annual salary is $87,645, her nest egg of $365,895 would be gone in about three years, at age 73.

We’re assuming that she has retirement income coming from other sources, such as Social Security or rental income, so this doesn’t mean she has zero retirement income — but it does mean her retirement income is cut in half after her retirement portfolio is depleted.


To put herself in a more secure financial position for retirement, she’ll simply need to save more money. If we retain the same salary and return assumptions, but she annually invests 10% of her income instead of 5%, she should end up with twice the amount in her portfolio.

That means, as shown in the top section of the “Running Out of Money” chart below, that her portfolio should provide half of her needed annual retirement income until roughly age 89. If she starts later, those numbers change: Her portfolio will last until age 81 if she starts saving at age 40; if she starts at age 50, her portfolio is drained by age 76.

Her position gets much stronger if she doubles her savings rate again: If she puts 20% of her annual income into her retirement portfolio starting at age 30, her funds will last until she is 106 — which, given increasing life spans, is not a totally unreasonable target. Starting at age 40, she should be fine until 92, which is no longer such a conservative life expectancy.

Any later, the picture looks problematic even with a such a high savings rate: If she starts at age 50, her money won’t last beyond age 81 — even if she is able to work until 70.

But remember, these outcomes assume that the portfolio is providing only half of the needed retirement income. Let’s say the retirement portfolio would need to produce all the needed retirement income. The expected outcomes are humbling, as you can see in the bottom half of the “Running Out of Money” chart below. 

Even if this individual starts saving 20% of her annual income at age 30, she will have portfolio-based retirement income only until age 89. And that’s a whole lot better than age 75, which is when she’ll run out if she saves only 5% each year during her working career.

For anyone who starts retirement saving at age 50 — and expects the portfolio to provide 100% of retirement income — the needed savings rate would far exceed 20%.

To put it simply, Americans must save more each year than they currently are.

Of course, very few Gen Y workers making $40,000 a year are your clients. But their parents may be — and it’s imperative (for the sake of the U.S. economy, as well as for your clients’ own financial peace of mind) that advisors help spread the message through any means available.
Meanwhile, there are some implications for clients in several age brackets.


Let’s take the more likely scenario, in which a retirement portfolio is expected to provide 50% of the needed retirement income.

There’s an easy rule of thumb here: For each additional decade of retirement income, your client should save another 5% chunk — but the correlation is tightest when clients start building a portfolio early.

For 30-year-olds, moving to a 10% savings rate from a 5% savings rate provides nine additional years of retirement income. Moving to 15% from 10% adds nine years, and moving to 20% from 15% adds eight years.

In general, adding an additional 5% to your savings rate lengthens the longevity of your retirement portfolio’s by nearly a decade.

The payoff is less generous for people who start saving later, though. Forty-year-olds who add another 5% savings chunk get about six more years of retirement income, and 50-year-olds who add another 5% savings chunk only get about three more years of retirement income.
In the alternate scenario — with no Social Security, trust, pension or other income, in which the retirement portfolio must provide 100% of the needed retirement income — the savings payoff is lower. 

At best, individuals can get five more years of retirement income with each additional 5% chunk of saved income — and that’s if they start saving at age 30. For older savers, each additional 5% chunk of savings gets only two to three years of retirement income; 50-year-olds actually get only one to two years for each additional 5% savings chunk.


These calculations assume a 9% annualized portfolio return before retirement and a 7% portfolio return during retirement — both reasonable assumptions. Using return assumptions that are higher is not a prudent approach, for two reasons.

First, higher expected returns come at the price of higher volatility, and higher volatility can distract and unravel even the most seasoned investors.

Second, increasing those return assumptions shifts the responsibility of preparing adequately for retirement from the person to the portfolio. Yet that responsibility should be squarely in the hands of the investor. No matter how fuel-efficient a car might be, its owner is still responsible for putting an adequate amount of gas in it.

If a person achieves a higher annualized return than 9% before retirement, great. But the retirement planning should be built on modest assumptions that keep the investor focused and committed.

We often hear the cliche, “No pain, no gain,” applied to athletic workouts. Yet it is eminently applicable to the process of financial fitness as well — particularly in the context of retirement planning.

The pain is represented by the effort and diligence needed to budget more carefully, which will allow for a higher savings rate. The gain will be a higher ending balance in the client’s retirement portfolio — as well as the development of enhanced budgeting skills, which will be valuable in every season of life. Let the savings begin. 

Craig L. Israelsen, a Financial Planning contributing writer in Springville, Utah, is an executive in residence in the personal financial planning program in the Woodbury School of Business at Utah Valley University. He is also the developer of the 7Twelve portfolio.

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