Sizing Up Your Nest Egg

A researcher offers a simple formula, based on your income and assets at different ages, to calculate how prepared you are for retirement

How do you know if you're on track for a financially secure retirement? There are a zillion ways to find an answer to that question, but in a time of financial and economic uncertainty perhaps the simpler the method the better. Brett Hammond, TIAA-CREF's chief investment strategist, has designed an easy way for employees to check on retirement readiness based on their asset-to-salary ratios at different points in their career. "The big problem is that there is no magic number for the amount of money you need," Hammond says. "This is an attempt to address the needs of real people. If you tell me your assets, income, and age, I can tell if you're on track for retirement."

Hammond's calculations start with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years. He argues that TIAA-CREF participants—teachers, hospital workers, and others in the nonprofit sector—would need to come up with some 50% of pre-retirement income from the accumulation of assets in their retirement savings plans, while corporate employees with higher income might need 60% from their 401(k)s, with Social Security filling in the gap. The wealthier you are, the smaller the percentage of retirement income Social Security will contribute.

How will you know if your nest egg will cover 60% of pre-retirement income once you stop working? If you're 35 and plan to retire at 65, you need 2.1 times your salary to be on track. By 45, you had better have 3.6 times. At 55, the multiple rises to 5.4 times. And by the time you retire, you'll want it to be 7.7 times.

Of course, there are some assumptions built in to Hammond's formula. He assumes a 10% contribution rate, including any employer matching contributions; 4% salary growth, a bit ahead of inflation; a 6% return on investments; and a 25-year retirement period to finance, which would be paid for by purchasing a low-cost annuity at retirement. Those are relatively conservative assumptions—except, perhaps, the 10% contribution rate.

When Hammond looked at the retirement readiness of a sample of TIAA-CREF's more than 3.2 million participants, he found the vast majority were on track. But their average savings rate of nearly 17%—including both employee contributions and those from their employers—is far higher than that of the typical 401(k) participant, which is in the single digits. Among those participants whose total contributions are less than 10% of their pay, their average assets about equal their salaries—nowhere near enough.

To see how ready the broader population is, Hammond aims to analyze 401(k) data from the Employee Benefit Research Institute. He also hopes to determine the minimum contribution rate for a safe retirement. "We have to stop talking about retirement in terms of assets," he says, "and start talking about it in terms of income."

Feldman is an associate editor with BusinessWeek in New York.