One of the trickiest things about planning for retirement is that it's hard to estimate your living costs years in advance. Imagine you're in your 30s and are trying to get a handle on what retirement might cost you. At this point, you might be 35 to 40 years away from that milestone. How on earth are you supposed to run numbers when we don't know what inflation has in store for healthcare, housing, and the other expenses you're apt to grapple with?
Plus, you may be too young to have a solid sense of what you want your retirement to look like. You might think you'll be happy spending your senior years traveling the globe. But as you get older, the idea of staying closer to home might hold more appeal.
That's why retirement planning is a tough thing to do -- no doubt about it. But one assumption you shouldn't make in the course of retirement planning is that you'll manage to get by as a senior with a fraction of the income you're used to living on. In reality, you should actually plan to replace the bulk of your income during retirement -- no matter what your specific lifestyle ends up looking like.
Don't lowball that estimate
Some people assume that come retirement, they'll get by just fine living on one-third or one-half of their income. But that's a mistake.
A lot of the basic expenses you pay for today are bills you're apt to incur during retirement. And so at a minimum, you'd be wise to assume you'll need about three-quarters of your current income to get by once you stop working.
In fact, if you already have loftier goals for retirement that include a lot of travel, you may want to assume you'll need the same income during your senior years. And that will require a fair amount of savings. The good news, though, is that if you give yourself ample time to build a nest egg, you might put yourself in a solid position to replace your pre-retirement income in full.
If you invest your savings largely in stocks, there's a good chance your investments will manage to generate an average annual 8% return over those 37 years. That's actually a bit below the broad market's average. And if so, you'll be looking at a nest egg worth over $1.2 million.
And speaking of Social Security, don't forget that you'll have those monthly benefits to look forward to. They won't be enough to live on, but if you do your best to file strategically, they might serve as a generous income source on top of the money you save yourself.
Do your best
Nailing down your retirement costs decades in advance is extremely difficult. That's why it pays to err on the side of needing a lot of replacement income. You might set yourself up to replace 85% of your former earnings only to manage just fine on 70%. But that's a far better scenario to land in than one that has you cash-strapped because you didn't save enough.