Saving enough for retirement could mean that you spend this special time of your life in comfort instead of worrying about how you'll pay your bills. But the amount that you need is unique to you and different from anyone else's number.
This may have you wondering which retirement planning method is best. And if you can't figure out what your first step should be, these four strategies can help you get started.
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Work backward
How much will your monthly Social Security payments be? And will you have any other income sources that you can count on like a pension or alimony? What expenses will you have? And will they be relatively the same as they are now?
After you have a good idea of what your income and expenses will look like in retirement you can roughly figure out how much in savings you'll need by the time you retire. Studies have shown that if you have 60% stocks and 40% bonds, keeping your withdrawal rate below 4% can help you avoid running out of money.
So if you determine that your expenses will be $40,000 and your income $30,000, you'll have a $10,000 gap. Generating this will take a first-year retirement account balance of $250,000. The table below shows how you could accomplish this if you save and invest annually over different time spans and rates of return.
| Time Period | 8% Rate of Return | 9% Rate of Return | 10% Rate of Return |
|---|---|---|---|
| 20 years | $5,100 | $4,500 | $4,000 |
| 25 years | $3,200 | $2,700 | $2,300 |
| 30 years | $2,100 | $1,700 | $1,400 |
Data source: Calculations by author via CalcXML.
Work forward
Even if you work backward toward your goals and learn that you need $5,000 annually, this may not be feasible. Alternatively, you can also get your retirement planning going in the present by starting off with a budget.
How much of your current spending is made up of things that you need versus things that you want? You can increase your savings by eliminating things like subscription services, but not paying your rent probably isn't an option. You can also look for ways that you can reduce variable spending. If your annual travel budget is $5,000, cutting it in half can help you save an extra $2,500 each year. And invested at a 9% rate of return over 25 years this could grow to $230,810.
Once you've done this you'll know how much you can realistically accumulate by the time you retire. And from there figure out how you can reduce your expenses in the years leading up to your retirement if it's not enough. Or how you can potentially create dividend or interest income streams that can help lessen the gap between your income and your expenses.
Multiples of your income
There are some rules of thumb that help you come up with a quick calculation of how much you should have saved now as well as how much you should have at various ages based on your income. The table below shows examples of this if you make $70,000 a year.
| Metric | By Age 30 | By Age 40 | By Age 50 | By Age 60 | By Age 67 |
|---|---|---|---|---|---|
| Multiple | One year's income | Three years' income | Six years' income | Eight years' income | 10 years' income |
| Amount Saved | $70,000 | $210,000 | $420,000 | $560,000 | $700,000 |
Data source: Calculations by author.
But sometimes how much you spend matters more than how much you save. And when using guidelines like this, important factors like your expenses are not considered. If you live in an expensive state like New York, housing costs alone may be a lot more expensive than if you live in a less costly state like Alabama. And if you are someone who has actively worked on reducing your expenses, you may need less than someone who hasn't, even if they don't make as much money as you.
Multiply your expenses by 25
Another rule of thumb you can use that does consider how much you'll be spending has you multiply the expenses that you'll have in retirement by 25. The table below shows how much you'd need in the future based on different expense projections.
| Expected Expenses | Retirement account balance needed |
|---|---|
| $10,000 | $250,000 |
| $20,000 | $500,000 |
| $30,000 | $750,000 |
| $40,000 | $1 million |
| $50,000 | $1.25 million |
Data source: Calculations by author.
Just like the 4% rule, this method assumes that you'll keep your money invested after retiring. It also requires some work on your part in estimating how much you'll be spending in retirement.
When using this calculation, it's essential that you maintain a manageable withdrawal rate. And if you take out 10% of your money in any year of your retirement, it could mean that your assets are depleted far sooner than you planned for.
Figuring out what you need for retirement is an estimate that could be a moving target as you get closer to the date. But the sooner you start planning for it, the more time you'll have for saving, investing, and making any tweaks needed along the way.
