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Are Today's Workers Dramatically Underestimating the Cost of Retirement?

By Kailey Hagen – Oct 8, 2021 at 6:08AM

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If you don't take these steps, you'll never know if you're off track.

The average worker believes they'll need about $500,000 to feel financially secure in retirement, according to a Transamerica survey. But there's a wide variance in opinion by generation. The median amount millennials feel they need to save is just $300,000, while baby boomers are more inclined to say they'll need about $750,000.

So which estimate, if either, is right? The answer is a little more complicated than you might think.

Person with hand on chin thinking

Image source: Getty Images.

There is no magic retirement number

Retirement planning, when done correctly, is highly personalized. So if one person says they'll need $500,000 for retirement and another believes they'll need $750,000, it's possible they're both right. Or they could both be wrong. It all depends on how their estimates align with their visions of retirement. But in the case of the examples above, it's likely that at least some of the workers surveyed are underestimating the cost of their retirement. 

The average household headed by an adult 65 or older spends about $47,579 per year, according to the Bureau of Labor Statistics, and receives about $27,081 in Social Security benefits. That leaves it with about $20,500 it must cover on its own every year. 

If we multiply this by 30 for a 30-year retirement, that amounts to $615,000 that the household members must save on their own. But in actuality, they'll need more than this because inflation will drive up the cost of living over time. Social Security benefits also rise over time, though these cost-of-living adjustments (COLAs) often don't keep pace with inflation.

Based on this, it's unlikely that most people would be able to live comfortably on $300,000 in personal savings, as millennials predict, or even the $500,000 that Gen Z and Gen X workers believe they'll need. But again, everyone's situation is different.

If a household plans to spend less than the average annually or believes it will receive more from Social Security, that could change how much it needs to save. If one or more members can count on a pension or other government benefits, that could also reduce the amount they need to save on their own. 

How to know what you need

To give yourself the best chance at a comfortable retirement, you need to have a good idea of how much you'll spend annually. The first step is to think about what you plan to do in retirement. Will you travel a lot or remain close to home? Do you plan to donate any money to charitable causes? Will any of your hobbies require additional spending? Get as clear a picture of your ideal retirement as possible.

Then, use this information to estimate how much you'll spend annually. You can use your current spending as a baseline, but remember to account for how your spending will change between now and retirement. You may have to budget more for travel and hobbies and probably some extra for healthcare, too. But you likely won't spend as much money on child care, and you won't have to save for retirement once you're already there.

Try to come up with an average amount you believe you'll spend per year and multiply this by the number of years you expect your retirement to last, adding 3% annually for inflation. A retirement calculator can do this for you. If you don't know when you want to retire, just choose any age to start with. You can always adjust this later. As for your life expectancy, plan to live into your 90s unless you have a good reason to believe you won't make it that long. It's always better to overestimate than underestimate.

Plan for an average annual rate of return of about 5% to 6% on your investments, even though your money may grow more quickly than this. If all goes well, you might be able to retire a little earlier than you initially planned. But if your investments grow more slowly than you'd hoped, at least you won't end up off track.

Your retirement calculator should tell you approximately how much you must save in total and per month to reach your goal. But you might not have to do it alone. You'll probably have Social Security to cover some of your retirement costs, and if you get a 401(k) match through your job, that'll also reduce what you must save on your own. Subtract the money you expect from these additional sources to determine what your monthly savings goal should be.

If you're not able to reach it for some reason, you might have to revisit your retirement plan. Consider delaying retirement to give yourself more time to save. Try a few different scenarios until you find a plan that works for you. 

It sounds like a lot of work, but once you get started, it shouldn't take you that long. Then, once you have a suitable plan, all you have to do is check in with yourself once every year or so to make sure you're still on track. You should also do this whenever you experience a major lifestyle change, like switching jobs or welcoming a new family member. Over time, it'll become pretty routine, and you'll feel more confident that you're heading toward the retirement you want.

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