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38% of Americans Are Wildly Underestimating the Cost of Retirement

By Kailey Hagen – Aug 29, 2019 at 4:06PM

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Here's how to avoid being one of them.

Even with a detailed retirement plan, your retirement savings estimate is always a number to be proved adequate (or not) in the course of time. The many guesses involved in creating a retirement plan lead a lot of people to essentially choose a number at random, but this is almost always a bad choice. You could end up saving too much and depriving yourself of enjoying activities and items you missed out on -- or worse, you could end up saving too little and running out of funds long before you reach life's finish line.

The latter scenario is more common than many realize. A recent American Advisors Group (AAG) survey reveals that many people are dangerously far off the mark when it comes to estimating their retirement costs. Surprisingly, 38% of people surveyed believed they would need less than $250,000 to retire comfortably, while 7% thought they would need less than $25,000. So how different are these estimates from reality? Let's take a look.

Mature woman removing a blindfold.

Image source: Getty Images.

The real cost of retirement

There is no magic number for retirement savings because everyone has different lifestyles, life expectancies, and goals for their retirement. But even if we just look at averages, we can see how off base the above estimates are.

The average household headed by an adult 65 or older spends about $50,000 per year, according to the latest Bureau of Labor Statistics data. Life expectancy varies, but the average 65-year-old retiring today has a one in three chance of living past 90 and a one in seven chance of living past 95, according to the Social Security Administration. Americans also vary in their preferred retirement ages, but a recent Gallup poll places the average retirement age at around 61. So for the sake of this example, let's assume a 30-year retirement.

When we multiply our $50,000 average annual expenses by 30 years, adding 3% annually for inflation, we end up with a total retirement cost of a little less than $2.4 million. But you don't have to save all of this yourself; Social Security will cover some of it. The average Social Security benefit as of July 2019 is $1,472 per month, or $17,664 per year. Over 30 years, this adds up to about $530,000. Subtracting this from our total, we end up with a cost of $1.87 million. If there are two former workers in the household, you'll probably get some more from Social Security, and if you're eligible for a pension or 401(k) match, that could further reduce the amount you need to save on your own.

But unless you expect to live a short life, work in retirement, or live very frugally, it's unlikely you'll be able to get by on less than $1 million. The 7% who think they'll need less than $25,000 might be surprised to find that doesn't even last them one year. And $250,000 could run out in less than a decade unless you have additional sources of income in retirement to supplement your savings.

How to create a personalized retirement plan

The example above is based on averages, but if you want to estimate how much you'll spend in retirement, you can follow the same steps. Estimate your retirement length by subtracting your planned retirement age from your presumed life expectancy. Then determine your estimated annual expenses in retirement, including housing, food, healthcare, and taxes. Use a retirement calculator to help you factor in inflation and figure out how much your current savings could grow between now and your retirement. Use a 5% or 6% annual rate of return to be conservative, though your actual rate of return could exceed this.

Your calculator should tell you how much your retirement will cost you in total and what you need to save per month to hit that goal. Subtract from these totals any money you expect from a pension, 401(k) match, or Social Security. (You can estimate your Social Security benefit by creating a my Social Security account and checking the IRS's prediction of your benefit.) The remainder is how much you must save on your own.

Try to save as much as your retirement plan recommends. If you can't, you have a few options. You can cut back your discretionary spending or increase your income so you can afford to save as much as you should. Or you can decrease your retirement costs by delaying your retirement, delaying claiming Social Security benefits, or reducing your retirement living expenses by scaling back your travel plans, for example.

No retirement plan is ever going to be perfect, but following the steps above will get you closer than taking a shot in the dark. Now's the time to start setting informed goals for your future.

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