Setting a clear goal for retirement savings is one of the first steps in planning for your future. Establishing a target amount to save can help you estimate how much to invest each month and let you track your progress. And it can help you estimate when you're ready to retire.
Some people might feel overwhelmed and won't know where to start when calculating what they'll need to save for retirement. But there are two really simple approaches that everyone can use to get a fairly good idea of what their retirement number should be.
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1. Assume you'll need 10 times your final salary
One of the simplest ways to set retirement goals is to figure out what your ending annual salary will be and assume you'll need 10 times that amount.
You can figure out your final salary by estimating the number of years left to retirement and assuming you'll get a 2% annual raise from your current salary. For example, if you're currently making $50,000, you'd assume you'll be making $51,000 next year and $52,020 the year after that, and so on.
If you're planning to retire in about 10 years, your final salary would be around $60,949, so your should set your goal for your nest egg to be about $610,000.
2. Plan to replace 80% of your final salary
There's another pretty simply approach, too, but it requires a few more steps and a few more assumptions.
Assume you must replace 80% of your final salary by the time you retire. Social Security is designed to replace around 40% of it, so your investment account balance would need to produce the remaining 40%.
You'll again need to calculate your final salary using the aforementioned method of assuming a 2% annual raise until retirement in 10 years. Once you figure out what income you'll be earning at retirement age, assume your savings will have to produce 40% of that amount with Social Security providing the rest.
If you ended up with that final salary of $60,949, 40% of that amount would be $24,379.60. So the next step is figuring out how much savings would give you that much income. To do that, you have to know your withdrawal rate -- the percentage of your account balance you'll be taking out each year.
One common rule of thumb says you can withdraw 4% in your first year and adjust upward by inflation each year, and you likely won't run out of money. To follow the 4% rule, simply multiply your desired income -- $24,379.60 -- by 25 to see how big your nest egg needs to be. This calculation shows you should aim to save about $610,000.
As you can see, both methods get you to the same place, which suggests they're effective at setting a realistic goal to build a secure future in your later years.
