One important aspect of retirement planning is coming up with your "retirement number," or how much money you'll need to save in order to retire comfortably. Unfortunately, there is no one-size-fits-all number for everyone. We all have different lifestyle expectations and sources of retirement income, such as pensions, 401(k)s, and Social Security.
So what's your number? Here are three tips from our experts that can help you come up with your own savings goal.
The most common guideline that financial planners use is known as the 4% rule. This rule says you should save enough so that the annual income you'll need in retirement is no more than 4% of your total retirement savings. So, put another way, if you have a good sense of how much yearly income you'll need in retirement, take that annual amount and multiply it by 25, and that will give you your savings target.
One thing to remember is that the 4% rule only takes into account your investment assets. So, if you have other forms of income, such as Social Security or private pension income, then you won't have to save as much in order to reach your annual cash target.
Many people criticize the 4% rule, with some saying it doesn't work as well if the market performs badly right after you retire. Others respond that the rule actually forces you to save more than you need during most normal market environments. What most people find is that they adjust their spending behavior in retirement if their portfolio falls on hard times, even though the rule itself says they don't need to. In any event, as a way of putting a number to a concept that can be hard to quantify, the 4% rule is a good starting point.
As Dan said, the 4% rule is a great place to start, but make sure you take special circumstances into account.
For example, one of the most common goals among workers is early retirement, but leaving the workforce early comes at a cost. If you can't keep your employer's health benefits and retire before you're 65, you need to factor in your health insurance costs, which can be rather high. And if you retire before 59-1/2, you may not be able to tap into your retirement savings in a 401(k) or traditional IRA, so all of your cash will need to come from readily accessible savings. So if you'd like to retire early, it might be best to overestimate your savings needs.
On the other hand, if you plan to work longer or are used to living well below your means, you may not need to replace quite as much of your preretirement income in order to maintain a comfortable lifestyle.
So the 4% rule is definitely a great starting point, but you should take into account your own goals and saving/spending habits when deciding how much money you'll really need to save in order to live comfortably in retirement.
To make your retirement planning manageable and ultimately successful, you need to put your energy into things you can control and not get too fixated on your retirement number.
Once you've established how much you think you'll need in retirement, figure out how much you need to set aside each year to reach that goal based on your timeline and situation, and then -- this is the best advice I ever got -- be conservative, always saving more than you think you'll need.
Life throws lots of off-speed pitches, and creating a margin of safety as far in advance as possible will make it easier to reach your retirement income goals with time to spare. Think about it this way: Based on the stock market's average rate of return over the past 30 years, every dollar you don't set aside today will take $4.66 to replace in 20 years.
One way to build that margin of safety is to take at least half of your raise each year and put it in your retirement, savings, or investment account. Do the same thing with any bonuses you get. It's a lot easier to spend less of your raise each year than to catch up on retirement savings 20 years later.
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