Few people want to work forever, which means you will need savings. While every American is already saving some thanks to Social Security, youll likely need more if you want to maintain the same standard of living in retirement you enjoy today.
And if you want to have a dream retirement, youll definitely need to make sure you save enough while youre working to reach your goals. Start by estimating what you need and working backward to a savings rate. If that seems tricky, follow along with this guide and youll be on track to a great retirement.
What You Need Drives What You Save
Many people save for retirement by just guessing what they should be saving. Many people save enough to get an employer 401(k) match, but so many dont save at all. And just because youre saving some doesnt mean youll have enough to sustain the same lifestyle in retirement if you dont save enough. If you can estimate your financial need during retirement, you can do a much better job of making sure you are saving enough.
Estimate Your Monthly Expenses in Retirement
Start by figuring out how much you spend in an average month today. Some finance experts suggest your expenses in retirement are about 80 percent of what they are today. However, odds are your financial situation will look quite a bit different from what it looks like now.
Ideally, you can pay off your home before you retire, you will drive less, have lower commuting expenses and your health insurance will be covered by Medicare. However, that doesnt mean every expense will go down. Its important to budget for travel, healthcare costs, periodic home maintenance and auto repairs, and anything else you might want to spend money on.
Take the time to create a fairly detailed estimate based on your current budget and expected changes. Also remember your income will likely be lower in retirement, but not zero. In the future, your Social Security and non-Roth retirement account draws are taxable income, but likely at a lower tax rate than you pay today. Taking everything into account, you can estimate your monthly and annual retirement expenses.
Estimate Savings Needs
Lets say you expect your monthly financial need in retirement to $4,000 per month, or $48,000 per year, which is not far off from the average retiree budget of around $3,700 per month. With that information in hand, we can calculate how much you need save for retirement.
But there is one big question: when will you retire and how long do you expect to live? If you plan to retire at 75 and live until youre 80, you only need five years of savings, or $240,000. But if you plan to retire in your 60s and live into your 90s, youll need significantly more. And since you dont know how many years you will live, its best to be prepared.
One of the most popular answers to this predicament is the 4 percent rule. The idea here is that you can withdraw 4 percent of your investment balance each year without ever depleting your initial investment.
If this is the case, it is easy to calculate your retirement savings goal. If you want $48,000 per year in retirement (or any other estimate), just divide by .04. In this case, the answer is $1.2 million. With that amount saved, you could hypothetically draw $48,000 per year and never run out.
Dont Forget Social Security
Thanks to the government, youve been saving for retirement every year you worked whether you liked it or not. Those lines on your pay stubs that say Social Security, Medicare or FICA, are coming back to benefit you in retirement.
Depending on your income during your career, how many years you worked, and when you plan to retire, your benefit may vary. Login to your MySocialSecurity account to get a personalized estimate right from the government. In 2017, the average monthly benefit for retired workers is $1,369 per month. The Social Security Administration estimates this to be about 33 percent of retirees income.
If you need $4,000 per month and have $1,400 per month coming from Social Security, you need to come up with $2,600 per month. That makes your total savings target, if you follow the 4 percent rule, a slightly more palatable $780,000.
Work Backward for Retirement Planning Success
Now you know exactly what you need to save to live comfortably in retirement and leave a good nest egg to the next generation thanks to the 4 percent rule. But how do you reach that giant savings milestone? If you work backward, you can see how the math works out.
If you are 35 today, have $10,000 saved for retirement, and want $780,000 when you turn 65, you can figure out exactly what to save. Over 30 years, you will have 360 months to save. To reach that goal using a no-interest bank account, you would have to save $2,167 per month.
But remember that when you save in an investment account for retirement, you do get interest every month. The handy compound savings calculator from the Securities and Exchange Commission tells us that earning 7 percent interest, you need to save $573 per month to reach your $780,000 savings goal. Thats still a lot, but much better than more than $2,000 per month.
This only works due to the power of compound interest and a long-time horizon before retirement. The later you start saving, the more you need to put away each month to reach your goal.
For comparison, if the interest rate goes to 10 percent, you only need to save $257 per month. But if you keep the same 7 percent interest rate and only have 20 years, you would have to save $1,420 per month instead of $573.
You Can Have a Wonderful Retirement
No matter your age and your current savings, a great retirement is possible. But its a lot easier if you start saving early, take advantage of the power of compound interest and consistently invest over time.