Everyone knows that if you truly want to have a financially secure retirement, you need to save and invest on your own. Because of this, people have tried to come up with what's called the retirement number: the target for how much money you need to save in order to reach the level of financial security you want. Yet in the debate over whether your retirement number should be large or small, many retirement savers lose sight of the fact that there is no one-size-fits-all retirement number that will work for everyone. To set a realistic savings goal, you must figure out what is important to you and what standard of living you want in retirement.
Can you really find a perfect retirement number?
There's a substantial gulf between the amount of money Americans have actually saved for retirement and what they might need to last throughout their golden years. Nearly three in five people surveyed in a recent study from the Employee Benefits Research Institute had saved $25,000 or less for their retirement, with more than a quarter having saved less than $1,000. Yet plenty of financial experts think you'll need $1 million, $2 million, or even more in order to sustain the lifestyle you want for your retirement years. Bridging that gap is the goal of many calculators designed to determine an exact retirement number and then show you how to reach it.
To get to those million-dollar numbers, the typical retirement number calculator makes some key assumptions about your expected retirement lifestyle. First and foremost, experts tend to believe you'll need somewhere between 70% and 85% of whatever income you had during your career in order to sustain the lifestyle you enjoyed prior to retiring. Their calculators therefore take those assumptions and then build in further guesses as to how much you can expect to earn through investing, the level of inflation between now and when you retire, and how long you'll live.
The end result is an incredibly precise retirement number. One calculator, for instance, said that for someone in their mid-40s earning $100,000 a year using a middle-of-the-road investing strategy, the exact retirement number is $2,844,957.
Why figuring out a realistic retirement number is far more complicated
The typical calculator makes it easy to come up with a retirement number, even if that figure is often intimidatingly high. The problem, though, is that the number most calculators spit out isn't tailored to your particular needs, for several different reasons.
First, many retirement calculators don't look at other sources of potential income. As nervous as many near-retirees are about whether Social Security will be there for them, its benefits make a huge dent into the amount you need to save for retirement. As fellow Fool John Maxfield noted a couple months ago, Social Security benefits typically provide between 20% and 50% of your pre-retirement income, getting many people more than halfway to their 70% to 85% income-replacement goal.
Second, calculators tend to be conservative about spending down your retirement savings so as to eliminate the threat of possibly running out of money. Simple methods like the 4% rule are designed not to reflect most common scenarios but rather to handle even worst-case situations with a margin of safety. That's a worthy goal if you can swing it, but many retirees are comfortable taking on a bit more risk, knowing they can always adjust their spending later if conditions turn out to be less favorable than they had hoped.
Most importantly, though, the baseline assumption that your income during your career reflects your spending habits now and in retirement doesn't have to be true at all. Instead, it makes sense to use a budgeting tool or other tracking method to look at how much you actually spend in a given year. For some who live above their means, you might actually need more than the 70% to 85% of pre-retirement income that financial planners suggest in order to sustain your lifestyle. For those who tend to save a lot toward retirement during their careers, current income levels don't really give a realistic picture of future spending, since they aren't spending all of their current income now.
How to plan flexibly
Rather than pegging your entire future on hitting an artificially precise retirement number, the smarter move is to use estimates of how much you might need in retirement as loose guidelines to help you establish a retirement-savings strategy. You can't expect to hit a retirement number on the button, but having a sense of where you're going will help you know if you get too far off-track. Moreover, by knowing you can adjust your spending in retirement to accommodate any unexpected bumps in your portfolio, you'll be able to go beyond a retirement number and still get the financial security you want.