Your Retirement Savings Scorecard
by Gerald Townsend, Financial Editor

Do you sometimes wonder if you are on track to have enough saved for retirement? You know you're not ready yet, but are you progressing at the rate you need to progress?

These are not easy questions to answer, but Charles Farrell, a financial consultant in Ohio, developed a simple table allowing a person to quickly determine where they stand.

While the table may appear simple, the math, logic and assumptions supporting it require a bit of explanation.

First of all, the foundation for these financial ratios is that there is an interdependent relationship between income, debt levels and savings rates. If your debt level is too high, you won't be able to save that much, since most of your cash flow goes towards paying down your debt.

Second, it is assumed that in retirement you will need 80% of your pre-retirement income and that Social Security will provide 20% of this, leaving your investments responsible for producing the remaining 60%.

Third, your investments will provide a 5% "real" rate of return. This means that the total return of your investments (income plus growth) will be 5% higher than the inflation rate. So, if future inflation averages 3% per year, your investments would be earning 8% per year.

Fourth, it assumes that in the initial year of retirement, you withdraw 5% of your investment portfolio. In future years, the amount distributed would be adjusted for inflation.

Now, with that background, let's look at the table:

Savings to Income shows, for various ages, the amount of savings that should be accumulated, compared with a person's income. Savings includes personal and retirement investments, but does not include the value of a home. So, the savings goal for a 40 year old, earning $75,000 per year is $127,500 ($75,000 x 1.7). Note that at age 65, the goal is 12 times income. Here's why: Given a 5% distribution rate in the first year of retirement, if you have savings equal to 12 times income, the amount distributed would replace 60% of your pre-retirement income, which is the plan.

Debt to Income shows the goal for what outstanding debts should be, compared with income. Debt includes mortgages, car loans, consumer debt, etc. Now our 40 year old who is earning $75,000 per year has a debt goal of $75,000 ($75,000 x 1.00). No doubt, you are shaking your head over this low level of debt. It gets worse. Notice that at age 65 the debt to income ratio is zero. That's right - no debt of any kind. This doesn't sound very realistic in today's market of super-sized homes and mortgages, but debt beyond these levels impacts the next ratio.

Savings Rate to Income is the percentage of your gross income you save and invest each year. Don't count investment earnings, just what you are putting in. Back to our 40 year old - this ratio results in a savings goal of $9,000 per year; but if their employer was contributing $3,000 to their 401(k), it would leave just $6,000 per year that would need to come from the employee.

A few observations:

You may view your home as an investment and want to include it, but most people are never able to utilize the equity in their home for retirement funding purposes - you have to live somewhere. Of course, if you own other real estate, this would be part of your savings.

This table is just a rough guide and uses many assumptions, so it may not be applicable in your personal situation.

If you aren't even close to these ratios, don't despair, but don't ignore them either. Use them to jump start your retirement savings or household budget plans and to evaluate your future progress.

For those interested in reading more about these ratios, send me an email.

Gerald A. Townsend, CPA/PFS, CFP®, CFA® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com.