Whether you’re just starting to prepare for retirement or you’re trying to figure out if you’re on track to reach your goal, it can be difficult to pin down an actual number for how much you need to have saved by the time you exit the workforce for good.
Here are some steps to take to figure out how much money you really need to have in retirement and some strategies to help you get there.
How to Find Your Retirement Number
To figure out how much you need to save every month for retirement, you need to know the total amount you want to save before you retire.
There are several different factors that you’ll need to consider to determine that figure. With these assumptions, you can use an online retirement calculator or work with a financial advisor to crunch the numbers.
1. Retirement Spending
If you’re working with a financial advisor, they may start by asking you, “What do you want your retirement to look like?” You’ll need to determine how much money you’ll want on a monthly basis to have the lifestyle you want.
If you’re having a hard time imagining that, some financial experts recommend using the 80% rule of thumb. This means to target having 80% of your pre-retirement income — your annual salary at the time you finish your career — once you’re in retirement.
The idea is that you’ll no longer have to pay Social Security and Medicare taxes, which make up 7.65% of your income, and you also won’t have to save for retirement and pay for work-related expenses like commuting.
2. Other Sources of Income
If you expect to receive a pension, annuity or Social Security income that isn’t related to your 401(k) or individual retirement account (IRA), make sure you include that in your calculation of what you need on a monthly basis.
For the sake of simplicity, let’s say you expect your pre-retirement income to be $100,000. If you use the 80% rule, you’ll need $80,000 in annual income from your retirement accounts.
Now, if you expect $2,000 per month to come from Social Security — you can get an estimate of what your benefit will be from the Social Security Administration — and another $1,000 per month from a pension, that’s $3,000 in monthly income ($36,000 annually) that you won’t pay out of pocket. It effectively reduces your responsibility to cover $44,000 per year in retirement expenses.
3. Investment Returns and Inflation
When you’re still decades out from retirement, you can afford to invest aggressively because short-term volatility won’t have much impact on your portfolio. However, the closer you get to retirement, the more conservative you’ll want to be with your investments because you don’t want to risk losing a large chunk of your money right before you leave the workforce.
And when you’re in retirement, the ultimate goal is to preserve your capital rather than to accumulate more wealth.
This means you’ll likely have a relatively low return on your investments while you’re in retirement. Consider speaking with a financial advisor to get an understanding of what that might look like and how it’ll impact your nest egg.
You’ll also want to consider how inflation will impact your portfolio, both leading up to and during retirement. Calculators and financial advisors can help you make proper assumptions about each of these.
4. Retirement Years
Knowing how much you need each year in income doesn’t help much unless you know how long you’ll be retired. Of course, that’s not a number you can predict exactly, but considering the average life expectancy may be a good starting point.
In some cases, especially if your family has a history of living long lives, you may want to extend your assumption to ensure that you don’t run out of money early.
Ways to Save for Retirement
There are several different ways you can save for retirement, many of which offer various tax advantages to make it worth your while:
- 401(k) or another employer-sponsored retirement plan: Your employer may offer a 401(k), 403(b), 457 or a similar plan to allow you to save for retirement. These accounts typically have relatively high annual contribution limits, and many employers offer to match your contributions up to a certain percentage of your income.
- Individual retirement account: IRAs allow people to save for retirement on their own without needing to go through their employers. You may choose between a Traditional or Roth IRA, which are similar for the most part, except for when you pay taxes. For many people, it’s best to start with a Roth IRA, but consider consulting with a tax professional if you have a high income. IRAs have lower contribution limits than employer-sponsored plans.
- Self-employment plans: If you’re self-employed, you may be able to set up a Solo 401(k), a Simplified Employee Pension (SEP) IRA or a Savings Incentive Match Plan (SIMPLE) IRA for yourself and, in some cases, your employees. These plans typically have higher contribution limits than standard IRAs.
- Health Savings Account: If you qualify for an HSA, you can make contributions and deduct them from your income for the year. Then you can invest those funds on a tax-free basis. You can opt to use your HSA funds to cover immediate medical expenses, or you can wait until you’re retired and use the funds to cover your healthcare expenses then.
There may be other retirement plans and options available to you. For information about your specific situation, consult a financial advisor.
If you’re thinking about opening an IRA or another retirement account on your own, shop around and compare providers like SouthEast Bank to determine the right fit for you.
The Bottom Line
If you want to know you’re saving enough for retirement, it’ll take time, effort and research to make a plan and do the proper calculations to make sure you’re on the right track.
As you consider your plans for retirement, consider working with a financial advisor who can help you explore your goals, run the numbers with the right assumptions and help you stay on track.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.
