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Attention, Higher Earners: Social Security Won't Cut It for You in Retirement

Maurie Backman, The Motley Fool

Though it's estimated that nearly half of U.S. households aren't saving for retirement, the country's highest earners are doing a seemingly decent job. As of 2013, the top 1% of U.S. households had $1.08 million or more set aside for retirement, according to data from the Economic Policy Institute. And that's a good thing, because it's the wealthy who stand to get hurt the most by counting on Social Security.

Social Security won't cut it for the rich

Relying on Social Security in the absence of independent savings is a bad move, no matter how much you earn. But it's especially dangerous for those with the top salaries out there. Social Security will replace about 40% of the typical worker's pre-retirement income. For households earning $150,000 or more, however, that percentage drops to just 27% on average. 

Senior man in tennis outfit holding racket.

Image source: Getty Images.

Why is this significant? Most retirees need roughly 80% of their former income to live comfortably in retirement. The less of that figure Social Security represents, the more savings you'll need to compensate.

Let's assume you earn $200,000 a year and plan to retire at your full retirement age. For the current year, the maximum Social Security benefit payable at full retirement age is $2,788 per month. Over a 12-month period, that's $33,456. However, if you're looking to replace 80% of a $200,000 salary, you'll need $160,000 a year, which means $126,544 will need to come from savings each year.

Now if you have several million dollars sitting in your nest egg, you're in pretty decent shape. But if you have a mere $1.5 million, and you assume a 4% annual withdrawal rate, which has long been the standard, that gives you just $60,000 of income -- only half of what you might need to live comfortably.

Of course, there are other means of generating income in retirement aside from tapping your nest egg and collecting Social Security. You might choose to continue working in some capacity and earn extra cash that way. Or, you might own a property you can monetize. But if those aren't options, and you're counting on your nest egg and Social Security alone, then you may need to ramp up your savings game significantly during your career if you want to maintain the comfortable lifestyle you've gotten used to.

Committing to building wealth

To hear that a $1.5 million nest egg may not cut it in retirement is no doubt discouraging. But if you're a higher earner, it means you have a real opportunity to max out your 401(k), assuming you have access to one, and build a substantial amount of savings over time.

Imagine you don't even start setting money aside for the future until age 30 and retire at 67. If you contribute the current annual maximum (which is $18,500 for workers under 50, and $24,500 for those 50 and older) during that period, and your investments bring in an average annual 7% return (which is actually a bit below the stock market's average), you stand to accumulate over $3.15 million dollars. If we apply a 4% withdrawal rate from savings, that gives you $126,000 a year in income -- the amount we were aiming for in our example above.

Furthermore, while maxing out a 401(k) might be a lofty goal for someone who's an average earner, if you're making $200,000 a year, you're talking about saving roughly 9% to 12% of your income, which isn't an unreasonable percentage.

Of course, if you're a high earner who's used to living well below your means, you may not need the 80% replacement income most people require. For example, if you're earning $200,000 annually but only spend about $7,000 a month on living expenses, you can probably get away with less in retirement, assuming you don't have plans to globetrot or live it up as a senior. But if that's not the case, you'll need to really work on maximizing that 401(k). Social Security will provide some income for you in retirement, but depending on your earnings, those monthly benefits could end up being negligible. You're better off saving for your own future so that you get to enjoy the good life you've worked so hard for.

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