Here's a pop quiz: Do you know how much you need to save for retirement? If you do, give yourself a pat on the back, because you're more financially aware than nearly half of American investors.
Only 53% of American adults have a rough idea of how much money they'll need to retire, according to a survey from Gallup and Wells Fargo, and the other 47% don't have a retirement number in mind at all. That's a problem, because your retirement number isn't something you can simply pull out of thin air. The average retirement costs around $738,400, according to a 2017 Merrill Lynch survey, and if you're taking a wild guess at how much you'll need to get by, you'll likely fall short.
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The second question on this pop quiz is arguably more important: How much can you withdraw each year to make sure your savings last through retirement? Even if you have a solid stash of savings, if you're pulling out way too much each year, those savings won't last long.
Of the 53% of people in the Gallup and Wells Fargo survey who had a retirement number in mind, only 40% had an answer to this second question -- and only half of that group had a "somewhat realistic" answer.
If you're among the majority of Americans who don't have a good answer to both of these questions, then read on.
Setting yourself up for success in retirement
The first step in figuring out your retirement savings target is to come up with a retirement budget.
Look at your past few months' worth of credit card and bank statements to get an idea of how much you're spending now. This will help you determine how much annual income you actually need to get by, which will then help you plan for retirement more precisely.
For example, if you've determined that you need $40,000 each year to cover all your financial needs and you expect to spend 25 years in retirement, you'll need at least $1 million in savings.
Granted, it's not quite that easy. There are other factors to consider when coming up with your retirement number, such as your shifting costs. Healthcare expenses alone cost individuals over age 65 more than $18,000 per year, according to the National Bureau of Economic Research, although only about 20% of those costs (around $3,600 per year) are paid out of pocket. Still, it's a good idea to build a buffer of a few thousand dollars per year into your retirement budget to account for these types of expenses.
Long-term care is another expense many retirees face as they age. Nearly 70% of Americans will require long-term care at some point in their lives, and the average monthly cost of a semi-private room at a nursing home is around $6,844 -- or over $82,000 per year. Long-term care insurance can help cover these costs, and although premiums may run several hundred dollars per month (the average 55-year-old couple pays a combined $205 per month), it may be worth purchasing to avoid paying tens or hundreds of thousands of dollars later on.
Before you panic too much over these costs, keep in mind that your expenses will likely decrease in other categories. For instance, you won't have to commute to work every day, so you can cut your transportation spending dramatically. On top of that, Social Security will supplement your savings, so you're not completely on your own in saving for retirement. The average beneficiary receives around $1,400 per month -- or $16,800 per year -- so if you spend 25 years in retirement, Social Security will provide about $420,000 during that time.
You can also use a retirement calculator to help with the nuances of retirement planning, such as inflation. Most calculators let you plug in numbers like how much money you have saved, your current salary and age, the age at which you want to retire, and how much you expect to receive in Social Security benefits. The calculator will give you an estimate of how much you'll need to have saved by the time you retire.
From there, you'll be better able to determine how much you can withdraw per year to retire comfortably. Say, for example, you expect to have $500,000 saved by the time you retire and plan to spend 25 years in retirement. If you withdraw 4% per year -- as is commonly recommended -- that amounts to around $20,000 per year, or $500,000 over 25 years (not accounting for inflation). If you're also receiving $1,400 per month in Social Security benefits, your total income will amount to around $36,800 per year, or $920,000 over 25 years.
These numbers aren't set in stone; your investments will continue to grow throughout retirement, and you'll need to adjust your withdrawal rate slightly each year to account for inflation and the performance of your investments. However, calculating your withdrawal rate doesn't need to be an exact science. Rather, it's more of an educated guess to help ensure you won't exhaust your savings.
Why these numbers are crucial for a comfortable retirement
The earlier you can come up with a retirement number, the more time you'll have to plan and save accordingly.
For example, let's say you've determined that you need around $800,000 to retire comfortably and don't have anything currently saved. If you're earning a 7% annual rate of return on your investments, here's how much you'd have to invest each month if you started saving 40, 30, 20, and 10 years before you plan to retire:
| Years Until Retirement | Required Monthly Contributions | Total Amount Saved |
|---|---|---|
| 40 | $325 | $807,793 |
| 30 | $680 | $799,724 |
| 20 | $1,575 | $803,890 |
| 10 | $4,650 | $799,888 |
As you wait to start saving, it becomes exponentially more difficult to reach your goal.
The second half of the equation, or the amount you plan to withdraw each year, ensures that your hard-earned savings last throughout retirement. If you go overboard and withdraw too much each year, you may be in trouble down the road.
Again, you don't need to have an exact number in mind for how much you can withdraw each year, but you do need a strategy. If you have $500,000 saved but plan on withdrawing $60,000 per year to cover your basic needs, for instance, those savings won't last long -- unless you only plan to spend around 10 years in retirement.
Creating a budget isn't the most exciting part of retirement, but it's crucial if you want the peace of mind that comes with knowing you have enough savings.
