As the reality of your retirement gets closer you’re likely feeling both excitement and apprehension. Balancing your expectations of the freedom that comes with retirement with the associated costs can be tricky so planning ahead is important.
It’s not too early to begin asking yourself, “How much money will I need to support the retirement I envision?”
Picture what you want your life to look like. Will you spend your days traveling the world? Do you plan to stay at home and garden or spend time with your grandchildren? Once you have answered these questions, you can create a plan and start to save the money you’re going to need. There are four factors you’ll want to examine before you begin retirement.
How Much Will You be Spending?
The general rule of thumb is to maintain at least 80% of your pre-retirement income. The 80% considers you won’t have payroll taxes for Social Security or money deposited into a 401(k). You’ll save money from no longer commuting to work, dry cleaning, and work clothes. Factor in your Social Security that you’ll receive or if you’ll receive a pension.
For example, if you spend $50,000 a year pre-retirement, you’ll want to have an income of at least $40,000 in retirement with the 80% rule. If you or you and your spouse collect $24,000 each year from Social Security, then you’ll need around $16,000 a year from savings. Keep in mind that if you withdrawal from a traditional IRA, 401(k), or tax-deferred savings account, gets reduced based on how much you pay in taxes.
The 80% rule doesn’t consider what you’ll spend either. Most people like to travel in the early stages of retirement and the costs can add up quickly. Medical care is another expense that doesn’t get factored in. Medicare Part B covers most doctor’s visits but runs about $148 or higher per month. Medicare also requires that you pay 20% of doctor bills and over $200 in deductibles. It’s estimated that almost $300,000 for a couple is needed to cover medical expenses in retirement.
Then, you must decide if you want to leave your children or grandchildren any inheritance. If you do, you’ll need bigger savings to cover all that you want to do.
How Much Will You Earn on Your Savings?
No one knows what stocks, bonds, or bank certificates of deposit will generate over the next 20 years. Economists have a rough percentage of what it gains based on history (10% for stocks, 5% for bonds, and 3% for treasury bills) but this can always change.
When most people invest, they don’t keep all of their money in one investment. They’ll put some in stocks to grow capital and put some in bonds to cushion a stock market decline. Financial planners caution their clients to invest low amounts for portfolios because the returns aren’t always the highest. If you aim too high, you risk losing too much money at once.
How Long Will You Live?
While that question isn’t easily answered, we can look at an average lifespan to get a general idea. According to Social Security, the average man lives to about 83 and the average woman lives to about 85 and a half. Most people when planning for retirement save with less life expectancy in mind. It might be worth considering how long your parents and grandparents lived. This can give you a clearer picture of how long you should save. On the safe side, estimate your retirement to last until you’re around age 90.
How Much Can You Withdrawal from Savings Each Year?
The 4% rule can help you decide this. You take your annual retirement income and divide it by 4%. For example, if you have $250,000 in savings, you can withdraw $10,000 the first year. Each year after that will need to be adjusted for inflation for the next 30 years. The higher the withdrawal rate (7% or more), the more likely you’ll run out of money before the 30-year timeline.
Savings by Age
It’s suggested that you have an equal amount to your annual salary by the time you reach age 30. This would require you to save 15% of your gross salary and investing 50% in stocks beginning at the age of 25. Ideally, you want to have two times annual salary at 40, four times at 50, six times at 60, and eight times at 67.
Another formula you can use requires you to save 25% of your gross salary each year beginning in your early 20s. By age 30 you should accumulate your full year’s salary. At age 35, two times your annual salary, three times at 40, five times at 50, six times at 55, seven times at 60, and eight times at 65.
Final Thoughts
Most Americans have the opportunity to boost their savings at the very least through a 401(k). While you may not have started saving at age 25, it doesn’t mean all hope is lost. You don’t have to follow these formulas exactly and oftentimes something will come up that throws you off the path. However, the more you can save, the better off you’ll be in the long run.