Published in: Banks | May 14, 2019

Ask a CFP: How Much Should I Be Saving for Retirement?

There’s no perfect answer to this classic personal finance question, but here’s how to determine your perfect number.A glass jar full of coins labeled Retirement and with coins stacked next to it as well.Image source: Getty Images.

Without knowing your specific situation, there’s no way for me to accurately determine how much you should be saving for retirement.

Having said that, a good rule of thumb is that you should aim for a retirement savings rate of at least 10% of your income -- not including any contributions your employer makes on your behalf. In other words, if you earn $60,000 per year, this implies that you should try to set aside $6,000, or $500 per month, specifically for retirement savings.

However, this is just a general rule of thumb. Here’s a quick guide that can help you figure out how much you’ll need to have in savings in order to retire comfortably, and how much you should be saving now in order to get there by the time you want to retire.

It’s not about retirement savings, it’s about retirement income

How much do you think you’ll need in the bank to be able to retire? $1 million? $2 million? More?

This is one of the most often-misunderstood parts of financial security in retirement. Being financially comfortable in retirement isn’t necessarily about the dollar amount of money you have in savings. Rather, it’s about how much sustainable retirement income you can create compared with how much retirement income you need.

For example, someone who is used to spending $200,000 per year and has $1 million in retirement savings isn’t likely to be able to create enough income to maintain their lifestyle after retiring. On the other hand, someone who is used to spending $50,000 per year and has a $2,000 monthly pension, $1,500 per month from Social Security, and a modest $200,000 nest egg could be perfectly comfortable in retirement.

Determining your ideal retirement nest egg

Here’s a quick four-step process to help determine how much retirement income you need, and the nest egg you’ll need in order to produce it.

  1. First, determine how much income you’ll need in retirement. A general rule is that you can expect to need about 80% of your pre-retirement salary to maintain the same standard of living. If you and your spouse make $100,000 now, it’s reasonable to expect that you’ll need $80,000 in annual income after retirement. Obviously this can be adjusted up or down to compensate for your anticipated lifestyle changes after retirement -- for example, if you plan to do a lot of traveling, you may need more income than this rule implies.

  2. Next, estimate how much recurring income you’ll have from other sources. Social Security is a big one, and you can get an estimate of your Social Security retirement benefits by creating an account at www.ssa.gov if you haven’t already done so and viewing your latest Social Security statement. If you have a pension from a previous job, or an annuity you’ve already paid for, that income falls into this category.

  3. Subtract the income numbers in step two from your overall retirement income need. This will tell you the amount of income you’ll need from savings. For example, if you estimate that you’ll need $80,000 in retirement income and you and your spouse can expect $35,000 from Social Security, this means that you’ll need $45,000 per year from savings.

  4. Another rule of thumb is that you can reasonably expect to withdraw 4% of your retirement savings in your first year of retirement, and give yourself cost-of-living adjustments in subsequent years, without fear of running out of money in retirement. While this rule is admittedly not perfect, it’s a good way to get a savings estimate. To apply the 4% rule, simply multiply the income you’ll need from savings by 25. Continuing my example, if you need $45,000 in annual income from your savings, this implies that you’ll need a retirement nest egg of $1,125,000.

How much should you be saving for retirement?

Here’s the more complicated answer to our initial question. The amount you should be saving for retirement depends on four main factors:

  •         The amount of money you anticipate needing to retire
  •         The amount of money you already have saved
  •         The amount of time before you want to retire
  •         Your expected investment returns between now and your retirement

For our purposes, we’ll assume long-term investment returns of about 7% on an annualized basis. Historically speaking, that’s what an appropriately-allocated portfolio of stocks and bonds has produced over long periods of time. Now, your year-to-year returns will likely vary significantly, and there’s obviously no guarantee that your portfolio will deliver this level of performance, but it’s a reasonable long-term expectation.

That just leaves two variables -- money and time. Just to warn you, the discussion is going to get a little mathematical from here on out.

An example: Calculating monthly retirement savings

Here’s a simplified example of a retirement savings analysis using nice round numbers. Let’s say that I have $100,000 in retirement savings and plan to retire in 20 years. Based on my retirement income needs analysis, I figure that I’ll need $1,000,000 in savings when I retire.

To determine how much you can expect your current retirement savings to grow into, here’s a formula to use, based on 7% annual returns:

Amount = (Current Savings) * (1.07)years

For example, if you have $100,000 saved and plan to retire in 20 years, this formula shows that you can reasonably expect your current savings to grow to:

Amount = $100,000 * 1.0720 = $387,000 (rounded)

The difference between this amount and your retirement savings need is the amount you’ll need to build from your future savings. So in my case, I’ll need another $613,000 to come from my savings.

Now, the mathematics of the monthly amount needed to reach a certain savings goal are beyond the scope of this article. However, the key takeaway is that the longer you have, the less you’ll need to save.

In my example, if I have 20 years to reach my $613,000 goal, I’ll need to set aside $1,165 per month based on a 7% annualized return expectation. If I want to retire in 15 years, my monthly savings need jumps to $1,900. On the other hand, if I want to retire in 25 years, I only need to save $755 per month to reach my goal.

Fortunately, there are several good “savings goal” calculators available online that can do the hard work for you. Here’s one that does a good job for retirement savings purposes.

Again, this is a simplified example and ignores a few things, specifically inflation and taxes. You can reasonably assume that inflation will make our money worth 2%-3% less over time, per year. And you can ignore taxes until retirement if you invest in a tax-deferred account like a traditional IRA or 401(k), but it’s important to account for taxes on dividends and capital gains if you invest in a taxable brokerage account.

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