If you don't know how much you need to save for retirement, you're not alone. In fact, in a recent survey by the Transamerica Center for Retirement Studies, 53% of respondents admittedly "guessed" when asked how they came up with their own retirement savings targets. The problem is that retirement is far too serious of a topic to leave it up to the results of a guessing game. While there is no one-size-fits-all way to determine your retirement number, here are some suggestions from our contributors to help you make an educated retirement plan.
Selena Maranjian: How much you'll need to sock away for retirement will depend, in part, on where you live. The cost of living varies widely across America and a nest egg that can serve you just fine in one area can be very insufficient in another. At Bankrate.com, you can use a cost-of-living calculator to get an idea of how much more or less costly various locations are than where you are now. For example, if you live in the Seattle area and move to Asheville, North Carolina, you'll find that you can roughly maintain your standard of living with 31% less income. You can get by on about 12% less if you move from the Denver area to greater Phoenix and on 14% less moving from Atlanta to Tulsa.
Don't just blindly trust an online calculator, though. To see where you might fare best financially in retirement, jot down some potential alternative retirement location for yourself and compare them with your current location. Think of towns you know you'd enjoy living in, perhaps ones where friends or family already live. Look up the local property tax rates, housing prices, costs for utilities and food, and so on. Incorporate your lifestyle, too -- for example, paying a lot of attention to recreation costs if you plan to do a lot of that, or travel costs if you expect to be moving around a lot.
Consider retiring abroad, too. It's not necessarily an easy choice, but there are some spots in the world that friendly to American retirees and that offer low costs of living and good healthcare, too. Panama, Ecuador, and Mexico, for example, have a lot to offer.
As you save for retirement, don't just assume you'll stay put -- especially if you find yourself behind in your savings.
Dan Caplinger: One way that many people assess their progress in saving for retirement is by looking at how big their retirement nest egg is in comparison to their salary. For instance, a few years ago, one study from Fidelity suggested that by retirement age, you should have eight times your annual pay set aside in retirement savings. The study also suggested intermediate savings goals, with your retirement savings amounting to a year's salary at age 35, three times your salary by age 45, and five times your salary at age 55. Some other studies have come up with slightly different targets, but most of them fall in a fairly close range.
One shortfall of the salary-based approach is that it focuses on income rather than spending. If you spend a typical percentage of your salary on regular expenses, then drawing conclusions from comparing your retirement savings to your salary will have a lot of validity. For those who save up a substantial portion of their savings, however, salary-based estimates will overestimate how much you need, because your actual spending is much lower. Therefore, using a salary-based estimate as a rule of thumb makes sense, but you need to be aware of the nuances of your particular personal situation to make sure the rule works for you.
Brian Feroldi: When most people are asked how much money is needed to fund a comfortable retirement they throw out a simple number like $1 million. That's a nice round number that seems to be a reasonable goal to aim for, however I think that using $1 million as a target isn't the best way. Instead, I think it's much smarter to take a look at your current total annual spending and simply multiply that number by 25. That should give you a much better estimate of how much you should be aiming for than blindly using the first number that comes to mind.
Why multiply by 25? The simple reason is that it's the inverse of the famous 4% rule, which states that an investor should be able to withdraw 4% of their portfolio's value each year in order to help ensure their money will last them throughout their retirement. Thus, if you manage to sock away 25 times your current annual spending amount for retirement then following the 4% rule should ensure that your money lasts through your golden years.
One counter-point to this assumption is that the 4% rule might not be a conservative enough withdrawal considering current interest rates, which is a fair point. If that has you worried then you might want to aim for a slightly higher multiple like 28 or even 30 to factor in a lower expected return.
However, don't forget that the 4% rule assumes that your retirement will be funded entirely by your nest egg, so we are not accounting for social security benefits (for you or your spouse), pensions or any inheritance that you might also receive. Any of those would add yet another layer of protection on top of an already conservative assumption, hence why I feel confident that simply using 25 times your current spending level is a great target to aim for.
Matt Frankel:Dan and Selena make some great points that your savings needs will depend largely on your location and spending habits. It's true that there is no one-size-fits-all way to calculate your retirement "number."
However, you can use some rules of thumb and other available information to get a pretty good starting point. As an example, here's the procedure I use to estimate my own retirement needs:
- The average retiree needs 80% of their pre-retirement income to maintain their lifestyle. So, multiply your annual income by 0.8.
- Some of this need will come from Social Security. You can try to estimate your Social Security benefit manually using this worksheet, but the easiest way is to register for an account at www.ssa.gov and view your Social Security statements.
- Subtract your estimated annual Social Security benefit from your retirement income need from step one. This is how much you'll need from your investments.
- Using the "4% rule" of retirement, multiply the amount in step three by 25 in order to determine your target nest egg.
This procedure should give you a good starting point, which can be adjusted upward or downward using some of the spending and location guidelines discussed by my colleagues.