Take a moment and picture your ideal retirement. Maybe you're sitting on the beach with your toes in the sand sipping a cold drink. Perhaps you're visiting your grandkids every weekend. Or maybe you and your spouse are traveling to faraway exotic countries and living the life you've always dreamed about.
Have a clear picture of what you want your 60s, 70s, and 80s to look like? Good -- you're now on your way to saving roughly 30% more for retirement.
It's as simple as that, according to a recent report from Capital Group. Researchers divided participants into two groups. The first group was asked to picture what they wanted their later years to look like and then determine what percentage of their paycheck they should put toward their retirement fund, while the second group was asked only how much they should save for retirement. On average, those who pictured their ideal retirement first said they planned on saving 31% more than those who were simply asked how much they should save.
This is great news for those who are struggling to save for retirement. Most people face competing financial priorities, from housing to healthcare to monthly bills, and retirement often gets shoved to the back burner because it's not an immediate expense. But then once you reach retirement age and realize you don't have enough saved to live comfortably, it's too late to do anything about it.
To avoid that scenario, it's crucial to set goals and keep your eye on the prize -- or in this case, that picture-perfect retirement lifestyle.
Step 1: Map out your day-to-day retirement expenses
Everyone wants a comfortable and enjoyable retirement, but it's hard to put a price tag on what exactly "comfortable" looks like.
Start by mapping out all your necessary expenses and how much they will cost. This includes everything from housing to groceries to car payments and everything else you'll need just to get by. Many of these costs will be similar to what you're paying now, so they may not require much guesswork and you can get a more accurate estimate of what you'll be paying during retirement. Other expenses (such as healthcare) will likely change as you get older, so you may not be able to predict what you'll be spending in these areas during retirement. Still, give it your best guess and err on the side of caution, budgeting more than you think you'll need.
Once you have all these numbers, add them up to see how much you'll need each year just to get by. This may not give you the ideal retirement you're hoping for; it's the bare minimum you'll need to make ends meet.
Step 2: Calculate your "fun" expenses
Next, figure out what you expect to spend on fun activities during retirement. If you're not planning on doing anything differently than you are now, this will be easy -- you'll likely be spending roughly the same each year after you retire as you are while you're working. But if you're planning on living a more lavish lifestyle filled with travel, new hobbies, or expensive nights out on the town, you'll need to adjust your budget.
You don't need to plan down to the penny, but you should have a good idea of how much all these activities will cost you. Run the numbers for what it would cost to take that dream trip to the Caribbean or that cross-country road trip -- it's better to find out what it costs now while you can still plan for it than to realize too late that you can't afford it.
Again, err on the side of caution here and assume that you'll be spending on the higher end of the scale. If you're not sure whether you'll be taking two or three trips per year, for example, budget for three -- it's always better to have extra room in your budget than to run out of money.
Then, once you've calculated these expenses, add them to your day-to-day expenses to see how much you'll need each year to live your ideal retirement lifestyle.
Step 3: Determine your retirement number
Your retirement number is how much you'll need to have saved by the time you retire, and it's based on what you expect to spend each year during retirement.
There are two guidelines to keep in mind as you're calculating this number: the 4% rule and the Multiply By 25 rule (sometimes referred to as the 25x rule or Rule of 25). The 4% rule states that you can withdraw 4% of your total savings during the first year of retirement, then adjust your withdrawals each year after to account for inflation. If you follow this guideline, your savings should last at least 30 years. Then, according to the Multiply By 25 rule, if you take the amount you'll need each year during retirement and multiply by 25, you'll see how much you'll need to have total.
So let's say you've determined that you need $35,000 per year just to cover all your basic expenses, and you expect to spend an additional $15,000 per year on non-necessities like travel, dining out, and hobbies. That brings your yearly total to $50,000.
Multiply $50,000 by 25, and you'll need to have $1.25 million saved by the time you retire. (Then, if you want to work backward, multiply $1.25 million by 4% to see that you can withdraw $50,000 your first year of retirement).
Step 4: Decide whether you can realistically reach that goal
If you want to have $1.25 million saved by retirement age, you'll need to save roughly $1,000 per month for 30 years earning a 7% annual rate of return. If you're only, say, 20 years from retirement, you'll need to up your saving rate to around $2,500 per month.
Is that feasible for most people? Probably not. In that case you have a couple options: Make sacrifices now so you can reach that goal, or reset your retirement expectations. If you've got your heart set on living a lavish retirement, it may be worth it to you to cut back on your current costs so you can save more. Or you may choose to take your spending down a notch during retirement so you don't need to adjust your current budget as much.
Saving for retirement is never easy, but sometimes it's more achievable when you start with the end in mind. Picture what you want your best retirement life to look like, and keep that image in mind as you're saving to remind yourself why it's so important to save as much as you can.