One of the biggest challenges in planning for retirement is knowing how much money you need to save up in order to have enough income as a senior. For most retirees, the bulk of their income comes from Social Security benefits and retirement savings accounts. If you can figure out how much money to expect from each of these sources, then you can plan out how you'll spend your retirement. And if the numbers look too low, you can adjust your savings plan while you still have the time.
Social Security benefits
Figuring out how much you can expect from Social Security is more of a challenge than most people realize. Social Security benefits are based on your earnings in the 35 years in which you earned the most money. The agency takes your earnings records, runs them through a weighting index to correct the numbers for inflation, and applies its formula to come up with your base benefit amount. The higher your average income, the bigger your benefit -- up to a limit.
The further you are from retirement, the less accurate any Social Security benefits estimate will be, because a lot can happen in the intervening years: Your earnings could go up or down, you could quit working altogether, or the Social Security formulas could change. It's a good idea to check your Social Security statement each year to see whether any dramatic changes have occurred. You can view your statement online on the Social Security website at any time. The figures in the Social Security statement assume that you will keep earning the same amount you earned last year (adjusted for inflation) until the day you retire.
When you open your Social Security statement, you'll quickly see that there are actually three estimated benefits amounts: one if you claim your benefits at full retirement age, another if you claim your benefits at age 70, and a third if you start taking benefits at age 62. That's because Social Security penalizes you for claiming your benefits early and adds a bonus if you claim your benefits late. So in order to get a realistic estimate of your Social Security benefits, you need to know when you're going to retire.
Retirement savings accounts
Your retirement savings accounts need to last you as long as you live, so it's important to limit yourself to a withdrawal rate that won't exhaust your accounts. The amount you can safely take from your retirement accounts will vary based on how well your investments performed over the last year and how old you are. As you get older, you'll be able to safely withdraw a higher percentage of your savings each year because the risk of overdrawing your accounts goes down as your remaining retirement time shrinks.
Assuming you retire in your mid to late 60s, you'll want to start by taking no more than 3.5% of your entire retirement savings account balance per year. Assuming your portfolio achieves average performance (say, around a 6% return for the year), that 3.5% withdrawal rate will be low enough to preserve your capital and even allow it to grow a bit, meaning you can keep drawing from those accounts for decades to come. While your withdrawal rate can go up later on, you should keep it conservative for the first few years of retirement, when big withdrawals can do the most lasting damage to your finances.
The first step in calculating your annual income from retirement savings is figuring out how much money you'll have in those accounts on the day you retire. A retirement calculator can help you come up with that number, based on how much you've already saved and how much you're contributing each month. Once you have a reasonable estimate for your account balances, you can multiply this number by 3.5% to determine your annual income from those accounts.
For example, let's say the retirement calculator estimates that you'll have $600,000 saved by your planned retirement date. You'd multiply $600,000 by 0.035 to get an annual income figure of $21,000. That works out to a monthly income of $1,750 from your retirement savings accounts. Add in the number on your Social Security statement based on your planned retirement date, and you'll have a reasonably close figure for how much monthly income you can expect during your retirement years.
What if it's too low?
If completing this exercise produces a result you aren't happy with, you have a few options. First, you can come up with ways to increase your retirement income. Delaying your retirement by few years, increasing how much you contribute to your retirement savings accounts, and raising your current income will all increase your retirement income. Second, you can reduce your expenses during retirement so that you can live comfortably on a relatively low income. For example, if you own your own home and you completely pay off the mortgage by the time you retire, you'll have no monthly housing payment, which should reduce your expenses by a considerable amount. The important thing to remember is that your retirement income estimate is just that -- an estimate. It's never too late to turn things around and come up with a plan to get you the income you need for the retirement you want.
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