Perspectives : DC Retirement | October 16, 2023

Increasing retirement readiness through higher savings rates and TDFs

Read time: 3 minutes

Workers who have access to a quality employer-sponsored retirement plan may be well on their way to achieving a secure retirement. But the path is less clear for those without access to a well-designed plan. According to Vanguard Investment Strategy Group’s Fu Tan, Kate McKinnon, and Andy Clarke, workers can increase retirement readiness in retirement plans by taking several steps, including the following that emerged from their recent research:

  • Increasing annual retirement savings to 12%–15% of income.1
  • Investing retirement savings in an age-appropriate mix of stocks and bonds, such as a target-date fund (TDF).

In their recently published paper, The Vanguard Retirement Outlook: A National Perspective on Retirement Readiness, Tan, McKinnon, Clarke, and their coauthors introduce the proprietary Vanguard Retirement Readiness Model and analyze the impact on readiness if all workers could save at recommended rates and invest in an age-appropriate asset allocation.2 They estimate the “sustainable replacement rate” for a broad range of workers, should they be able to save at recommended rates and invest in a TDF.  The sustainable replacement rate is the highest level of spending as a share of pre-retirement income a worker can sustain in 90% of capital markets and mortality scenarios.

“The results are a dramatic boost to readiness, particularly for lower- and middle-income workers in the younger generation,” Tan said.

Saving at recommended rates can make a big difference

Readiness, as measured by the sustainable replacement rate, improves significantly for workers in the bottom quartile for income when they simply save at least 12% of their income annually versus the less than 5% on average they have saved historically.3 “We focused our research on millennials and assumed they remained invested in a cash-heavy asset allocation,” Tan said. “We found that in the 25th percentile [of income] for this group, the sustainable replacement rate rises from 64% to 78% of pre-retirement income, and a bump in savings to 15% boosts the sustainable replacement rate to 83%.”

She added that saving between 12% and 15% also increases the sustainable replacement rate for middle-income workers, albeit more modestly. The impact is negligible for higher-income millennials, who typically save at rates close to or above those recommended during their working years.

Saving more has a large impact on sustainable replacement rates for low- and middle-income millennial workers

Sources: Vanguard Retirement Readiness Model and Vanguard calculations, based on data from the Federal Reserve Board’s Survey of Consumer Finances, the University of Michigan Health and Retirement Survey, and the Social Security Administration. 

Age-appropriate asset allocations can help

Tan, McKinnon, and Clarke then estimated a new set of sustainable replacement rates for each income group in the millennial generation, exploring the interaction of 12%–15% savings rates and investment in a TDF. Their work can be summarized in three key findings:

  • Holding more household assets in a TDF significantly changes one’s allocation to stocks and bonds. Historically, workers have had modest allocations of their savings to stocks and bonds. Lower-income workers hold a higher fraction in cash (70%) than higher-income workers (30%).4 And those who haven’t held all their noncash assets in a TDF hold, on average, about 50%–60% of these assets in equities. However, those who hold their noncash assets in a TDF have an equity allocation to their portfolio of 90% early in their working years; this is gradually reduced to about 30% in retirement.

  • All workers can benefit from saving at recommended levels and investing these savings in a TDF, but that’s particularly true for lower- and middle-income workers. The figure below displays the researchers’ findings. For each income group, they calculate the gap between projected replacement rates and estimated retirement needs. For workers with incomes in the 25th percentile, for example, the gap is 32 percentage points. But if they save 12% and leave their asset allocation unchanged, the gap shrinks to 18 percentage points. If they save  12% and invest in a TDF, the gap shrinks to 2 percentage points. And if they save 15% and invest in a TDF, the gap disappears. In fact, these workers are projected to have more than their estimated income need. The effects are directionally similar, but less dramatic, for higher-income workers, simply because these workers have smaller gaps between their projected replacement rates and estimated needs.

    The researchers also found that higher savings amplify the impact of a TDF asset allocation. Low-income workers (in the 25th percentile) would boost their sustainable replacement rate by 6 percentage points (reducing the savings gap from 32% to 26%) when investing in a TDF asset allocation compared with an asset allocation with a higher cash holding and keep their savings rate at less than the 5% historical rate. However, if they could save more at a 12%, they could sustain 16 percentage points more of their retirement spending (reducing the savings gap from 18% to 2%).

Retirement savings gap for millennials by scenario and family income

Source: Vanguard calculations based on data from the SCF, the HRS, and the Social Security Administration. Empirical savings rate refers to actual savings rates and patterns.
  • TDF asset allocation has a bigger impact on long-term retirement readiness for lower-income workers. This is because lower-income workers tend to be even more heavily invested in cash than other income groups. However, Tan, McKinnon, and Clarke note that it may be worthwhile for many investors, particularly those with lower incomes, to hold cash and cash-equivalent assets for emergency needs.

The road ahead

Is it realistic to expect that workers can save 12% to 15% of their earnings? McKinnon points to the Australian system, which facilitates individual retirement savings through a mandatory employer contribution called the Superannuation Guarantee, which was introduced in the early 1990s. Currently, this savings rate is 11% of workers’ earnings and is scheduled to rise to 12% in 2025.

The policy has catalyzed broader plan coverage, from around 40% of workers in Australia in the 1980s to more than 90% today; higher levels of retirement wealth; and lower government pension spending. “The results are impressive,” McKinnon said. “Whether you agree with a compulsory retirement savings [plan] or not, the results in Australia suggest the power of features that could help overcome investor inertia, such as autoenrollment and autoescalation.”

Actual savings rates and patterns in the U.S. underscore the challenge and highlight the significant opportunity for policymakers and plan sponsors to promote increased access to retirement plans and capital markets, especially for lower- and middle-income workers, and to double down on good plan design to help all workers become and stay invested.

Clarke believes that behavioral interventions tied to workplace plans as outlined in Vanguard’s How America Saves are having a big impact on encouraging workers to save more for retirement and invest these savings in an age-appropriate asset allocation. More can be done on the policy front and by employers to strengthen retirement savings as workers switch from job to job and sometimes don’t have access to a retirement plan.

“We realize that these recommendations, particularly the one to save 12%-15% of income, may be difficult if not impossible for the lowest income workers,” he said. “But the adoption by plans of best practices such as autoenrollment, autoescalation, and defaulting participants into a TDF are helping to narrow the gap at all income levels and better prepare workers for a secure retirement.”

1 Includes any employer match.

2 This research uses the Vanguard Retirement Readiness Model, which uses data from the Survey of Consumer Finances (SCF) to analyze household balance sheets of future retirees grouped by generation (baby boomer, Gen X, and millennial) and percentile in the income distribution (25th, 50th, 70th, and 95th). The data are used to estimate a sustainable replacement rate—spending levels expressed as a percentage of pre-retirement income, including Social Security and private savings, that can be sustained in 90% of capital markets and mortality scenarios. The projected sustainable replacement rate is then compared with spending levels in retirement by income percentile.

3 Sources: Federal Reserve’s Survey of Consumer Finances, 2007-2019, and Financial Accounts of the United States.

4 Source: Federal Reserve’s Survey of Consumer Finances, 2007-2019, and Financial Accounts of the United States.


  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
  • Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a target-date fund is not guaranteed at any time, including on or after the target date.