Here's a retirement planning tip: The point of saving and investing for retirement isn't necessarily to hit some magical number. Instead, it's to ensure that you'll have enough sustainable income for the rest of your life. While there's no one-size-fits all formula to determine how much income you'll need in retirement, here's how to get a good idea of your post-retirement income need, and how this can be incorporated into your retirement planning strategy.
The 80% rule is a good place to start
A widely used rule of thumb is that if you want to maintain the same quality of life after retirement, you should plan to need roughly 80% of your pre-retirement income. So, if you earn $50,000, you'll need $40,000 to keep up the same standard of living you enjoy now.
The idea here is that after you retire, there are certain expenses you won't have anymore. For example, you won't be setting aside a portion of your salary to save for retirement. And you may not have job-related expenses like putting gas in your car to commute every day. This is why they say you'll need 80%, not 100%, of your income.
Adjust the rule to fit your goals
Of course, not everyone wants to maintain the same lifestyle after retirement. Some people plan to travel the world after retirement, and will therefore need more money. Others plan to downsize their home and live a simple lifestyle, and could get by on a much lower budget. The point is that you should start with the 80% rule and adjust it accordingly.
Just to name a few, reasons you may need more than 80% of your pre-retirement income include:
- You plan to travel more in retirement.
- You want to pursue an expensive hobby, such as sailing.
- You're retiring before age 65 and won't initially be eligible for Medicare, and will have to cover healthcare expenses.
On the other hand, reasons you may be able to get by on less than 80% of your pre-retirement income could be:
- You pay certain bills now that you won't have to worry about in retirement. For example, if you'll have your home paid off before you retire.
- You've always been a super-saver. In other words, if you save a high percentage of your income, you're probably using less than 80% of your income to pay for your lifestyle.
- You plan on cutting back on expenses, downsizing your home, or otherwise planning to live a simpler lifestyle than you currently do.
How to use your income target
Using your income target, you can create a ballpark estimate of how much you'll need to save in order to create this level of income on a sustainable basis.
While you're doing this, keep in mind that your savings won't be your only source of income in retirement. Social Security, for example, should be taken into account, as should any pensions or annuities you expect to receive. In other words, if you determine that you'll need $60,000 per year in retirement, and expect to get $20,000 per year from Social Security plus another $15,000 from a pension, this means that just $25,000 will need to come from your savings.
Having said that, the "4% rule" of retirement is a good place to start. The basic idea is that you can realistically expect to withdraw 4% of your retirement savings during your first year of retirement, and give yourself cost-of-living increases in subsequent years, without having to worry about running out of money. To apply this rule, simply multiply your income need from savings by 25.
To be clear, the 4% rule isn't perfect. Just like the 80% rule for income, this can be adjusted up or down based on your risk tolerance. For example, a conservative investor may want to withdraw just 3% of their assets per year, while an aggressive investor with plenty of savings may feel comfortable withdrawing 5%.