When you set your retirement goals, you must make some key assumptions about your future so you can determine how much you'll need invested.
Unfortunately, the majority of Americans are probably making one major assumption that's incorrect -- and that could cost them. Learning the truth is crucial to avoid ending up with a financial shortfall as a retiree.
This is the number every future retiree needs to see
According to a recent report from J.P. Morgan, seniors on average are spending at least 90% of their pre-retirement income and many are spending more. This key number shows that the reality of retirement is way different than many people expect -- and your current expectations when setting retirement goals may not be realistic.
See, many people who are planning for retirement assume they'll need to replace about 80% of pre-retirement income, and some financial experts even suggest you could get by on as little as 70%. But if you're anticipating your replacement rate will be this low while data from current retirees shows most don't cut their costs nearly that much, you could be dangerously underestimating your future needs.
Say, for example, that your pre-retirement salary is $60,000 and your Social Security benefits add up to around $20,000 per year. If you expect to replace 80% of your pre-retirement earnings, you'd assume you'll require $48,000 in total income. Your investments would have to provide around $28,000 in annual income in addition to your Social Security checks.
You'll need a safe withdrawal rate to avoid draining your nest egg. If you follow the 4% rule -- which says you won't run out of money if you take 4% out of your retirement account the first year and adjust upward by inflation -- you'd need a nest egg of $700,000.
So, how much should you actually be saving?
But, if you actually spend 90% or more of your pre-retirement income, as the J.P. Morgan study suggests current retirees are doing, your account balance must be larger. If you're aiming to replace 90% of $60,000, that's $54,000 in total income -- and your investments must produce $34,000 to supplement Social Security. You'd need a whopping $850,000 to follow the 4% rule and produce the required amount of retirement funds.
If you're basing your retirement goals on the assumption you'll cut your spending down to 70% or 80% of pre-retirement funds, you're likely to find yourself in dire straits if you follow the path of most current retirees. And, unfortunately, while you may anticipate that you can just be more frugal, that may not be possible given rising inflation -- and the fact much of the money seniors spend tends to go to things like housing and medical services. These aren't usually optional expenses.
To make sure you don't find yourself facing a shortfall, set your retirement savings goals with the assumption you'll have to replace at least 90% and perhaps as much as 100% of pre-retirement income. Yes, this means you must save more now -- but you'll be a lot better off later when you have enough to live on without worrying about draining your nest egg dry.