Saving for retirement is likely one of the greatest financial challenges you'll ever face. It takes decades to successfully prepare for retirement, and you'll likely need to save hundreds of thousands of dollars (if not more than $1 million) to enjoy your senior years comfortably.
While there's no one-size-fits-all approach to preparing for the future, there is one thing you can do right now that significantly increases your chances of saving enough and succeeding in retirement -- and it's easier than you may think.
The best retirement plans start with a budget
When you think about all the factors involved in retirement planning, many of them focus on how much you'll be spending during your senior years. To figure out how much you have to save by the time you retire, you first need to know how much you expect to spend each year in retirement. And to estimate that number, you need a retirement budget.
Creating a retirement budget will give you a good idea of what your future expenses will look like, which is the foundation of your retirement plan. You may end up spending far more or less in retirement than you do now, and if you don't have a clear picture of all the costs you'll face in the future, it's next to impossible to accurately prepare for them.
A solid retirement budget can also help you avoid overspending. It can be tempting to throw caution to the wind and withdraw as much as you like from your retirement fund each year, but if you don't stick to a budget, you risk withdrawing too much too early and running out of money down the road.
Finally, you can avoid getting stung by costs you weren't expecting when you have a thorough retirement budget. There are so many expenses you'll face in retirement, and not accounting for even one of them could be a costly mistake. When you plan for these costs ahead of time, though, you'll have peace of mind knowing you've done everything you can to prepare for any expense life throws at you in retirement.
How to create a retirement budget
You may not be able to predict every single cost you'll incur in retirement, but a good estimate is better than nothing. To create your retirement budget, first make a list of all the expenses you may face.
Start with basic living expenses, like housing, food, and transportation. Unless you're planning on making a big life change in retirement -- like moving to a new city or downsizing to a smaller home -- these costs may not be drastically different from what you're paying now. But be honest with yourself here, and really think about what your retirement lifestyle will look like. If you plan to eat out at restaurants more often or do more shopping in retirement, for example, be sure to include that in your budget.
Next, think about some of the more significant costs, like travel, hobbies, or home renovations. Again, you don't need to budget for these expenses down to the penny, but at least get a basic idea of how much you'll likely spend. Especially if you have a lot of bucket-list activities you can't wait to accomplish in retirement, you may need to budget several thousand dollars per year toward these costs.
Then there's the not-so-fun part of budgeting, which involves planning for costs like healthcare, taxes, and long-term care. Each of these expenses can take a huge bite out of your savings, so the more accurately you can plan for them, the better off you'll be. For healthcare, think about any Medicare-related costs you'll face -- like premiums, deductibles, coinsurance, and copays. For taxes, be sure to budget for any income taxes and taxes on Social Security benefits. And for long-term care, consider whether long-term care insurance is a good option for you. Again, these expenses aren't fun to think about, but planning for them now can save you a lot of headaches and frustration down the road.
Finally, one last thing to build into your budget is an emergency fund. No matter how much you plan for retirement, you won't be able to predict everything. But having around six months' worth of income stashed in an emergency fund can ensure you won't end up withdrawing too much from your savings if you're hit with an unexpected expense.
The next step of the puzzle: factoring in your income
Once you've got a good idea of how much you'll be spending each year in retirement, consider your income sources -- like a pension or Social Security benefits. You can get an estimate of your future benefit amount by creating a mySocialSecurity account online, which will give you a good idea of how much of your retirement income will need to come from your savings.
For example, if you've created your retirement budget and estimate your total expenses will come out to, say, $60,000 per year and you'll be receiving $20,000 per year in Social Security benefits, that means the other $40,000 per year will need to come from your savings -- assuming you have no other sources of income.
Now when you're calculating how much you should have saved by retirement age, you'll know your estimates are far more accurate. Although there's no way to 100% guarantee you'll have enough saved to retire comfortably, the more thought you put into your retirement budget, the better a chance you have of making your savings last the rest of your life.