You know you need to save for retirement. But have you figured out how much you’ll need down the road to live comfortably?
Saving money for retirement can be tricky because you don’t know what your life will be like in the future. However, that doesn’t mean you shouldn’t put together a realistic estimate.
In fact, creating an estimate for how much you need to retire can help you plan now. And the earlier you start, the more likely you are to have a comfortable retirement.
How much should I save for retirement?
The amount you need to save for retirement depends on what you want to accomplish, when you want to retire, and how soon you start saving.
According to the Employee Benefit Research Institute (EBRI), 22 percent of workers don’t know how much of their income they need to save for retirement.
Even those who say they know how much they need to save could be wrong, however.
A 2014 EBRI report indicated that only 44 percent of workers have even attempted to calculate how much money they need to save for a comfortable retirement.
If you haven’t sat down to figure out what you need in retirement, now is a good time to take a look. It’s fine to say that you need to save 10 or 15 percent of your income, but is that accurate? And will it really give you the nest egg you need to be comfortable during your retirement years?
Here’s how to start your retirement needs assessment.
What do you expect out of retirement?
If you want to answer the question, “How much should I save for retirement?” you need to consider your plans for the future. What do you want your retirement to look like?
If you decide you want to downsize and mostly putter around town, playing a little golf and taking a few classes at the university, your retirement probably won’t cost much. On the other hand, if you decide you want to travel, you might end up needing much more in retirement.
I figure my “retirement” will look similar to what I do now: making money from writing, traveling when I can, and being involved in my local community.
Using your current income as a starting point, consider how much money you might need each year to live your desired lifestyle. That’s more important than trying to figure out what percentage of your income to save.
Can you be comfortable on $40,000 a year, or do you require something closer to $80,000 a year? Look at your current monthly expenses. Chances are you will need at least that much each month in retirement — or maybe more if you hope to live a different lifestyle.
The 4 percent rule
For years, gurus have touted the 4 percent rule as a way for you to estimate what you need to save for retirement.
The idea behind this rule is that you can plan to withdraw 4 percent of your assets from your retirement account each year for your nest egg to last indefinitely. The thinking is that your asset allocation in retirement should yield you about 7 percent annualized returns, and you need to subtract 3 percent from that as an average inflation rate.
So, if you need $40,000 a year to live comfortably, you take $40,000 and divide it by 0.04. The result is $1 million — that’s how much you’d need in your nest egg. For an annual income of $60,000 a year, you would need to save $1.5 million for retirement.
There are problems with the 4 percent rule, and you shouldn’t blindly rely on it. However, it can provide you with a reasonable estimate of what you might need to save for retirement if you expect to base your income on withdrawals from your saved nest egg.
When do you need the money?
Your next move is to think about when you will start withdrawing money for retirement. The longer you have to build your nest egg, the less you need to contribute each month.
Use a retirement calculator to help you figure out how much you need to save to reach your goal. If you want to build a retirement account up to $1.5 million by age 65, you will need to set aside much less if you start at age 25.
Bloomberg has a great retirement calculator that illustrates the importance of starting early.
As you can see above, you need to save $5,790.24 a year to hit that target if you start at age 25 and assume annualized returns of 8 percent. That works out to $482.52 per month.
Now, consider what happens if you wait until you’re 35 to start saving for retirement:
By waiting 10 years, you end up needing to save $13,241.15 a year. That’s $1,103.43 per month — a much bigger chunk of change to reach your goal.
Of course, if you want to start withdrawing money before age 65, you need to save more each month because you will have a shorter time frame to work with.
Consider monthly income streams
Another way to approach the “How much should I save for retirement?” question is to work on building monthly income streams that meet your needs.
I set aside money in tax-advantaged retirement accounts and use a Health Savings Account as part of my strategy. However, I also expect to keep working well into “retirement.” I’m not sure I’m planning for what many of us think of as retirement.
If you know you will need $4,500 each month to meet your expenses and your idea of a comfortable lifestyle, start planning now to create the income you need. This can include building a massive nest egg, but you can also take other steps:
1. Pay down debt
Work toward paying down student loans and mortgages now, so you aren’t burdened with higher debt later. The Urban Institute reports that the share of housing debt among retirees is on the rise, and the EBRI reports that debt levels at retirement continue to rise.
The fewer financial obligations you have in retirement, the less you need each month to meet your needs.
2. Look for side income
You can give your nest egg more time to grow or reduce how much you need to withdraw each year by developing a side income. There are plenty of side hustles available that can help you create income streams that you can maintain for decades.
3. Start a business
A good business can provide you with an income stream for years. Thanks to technology, it’s possible to launch a business from the comfort of your home. Work on your business in your spare time, and it could provide you with a little extra for your retirement account plus set you up to continue receiving income during retirement.
4. Taxable investment accounts
It’s possible to use taxable investment accounts to provide you with income down the road. Start building a dividend portfolio today, and you could live off payments decades later.
5. What about Social Security?
It’s nice to think that Social Security will at least provide you with a few hundred dollars a month toward your monthly income stream once you’re eligible. Unfortunately, that might not be the case. In the current political climate, Social Security as we know it is on the chopping block.
Plan to take care of yourself in retirement. If Social Security survives into your retirement years, that’s an added bonus.
The importance of multiple strategies when saving money for retirement
In the end, saving money for retirement is about creating strategies that are likely to help you meet the challenges you will face as you age, including rising health care costs. Don’t rely on just one strategy to figure your retirement needs and build your income.
The coming decades will bring many changes and challenges. Make sure you plan ahead so you can thrive, no matter what happens.
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