Figure Out How Much You Need to Save for Retirement
If you're like many people, saving for retirement is a high priority for you. You may be participating in your employer's retirement plan or contributing to an IRA (or both). But how much do you need to save in order to retire comfortably? The answer to this question will depend upon several factors and will be different for each person.
Estimate your expenses
The first step in determining how much money you will need to retire is to create a cash-flow projection of your income and expenses after you stop working. Get an estimate of your Social Security benefits from the Social Security website or use their calculator to estimate how much you will receive. Then add in any pension income that you may be getting to determine your annual gross income at retirement. Then project what your monthly expenses will be when you retire. Most financial professionals tell their clients that their monthly expenses during retirement will likely be about 80% of their current expenses. Of course, if your house will be paid off by the time you retire, then your expenses may decrease more than that. But think realistically about how much you will spend during retirement and include the costs of any hobbies or other activities that you will pursue.
Next, compare those expenses to your total projected income to determine where you stand. In most cases, your Social Security benefits alone will not cover your expenses. If you're lucky, a pension might make up the difference, but you will most likely need to rely heavily on your own retirement savings.
Estimate your savings
The next step is to determine how much you'll need in savings to generate the income you expect to need in retirement. You will need to use a financial calculator in order to do this. Several excellent calculators are available online; a quick Google search should get you a list of them to choose from. Enter the amount of savings you have now for your starting balance and then estimate a rate of growth for your savings. Be realistic with this; a 12% rate of growth is probably a bit optimistic. Also enter in all of your future contributions that you will make to your retirement accounts. The calculator will then tell you what your retirement portfolio might be when you stop working.
The final step is to then compare your annual income shortfall to the amount you can safely withdraw from your savings each year. Most financial planners say a withdrawal rate of 3% to 4% per year will allow you to draw income without exhausting your savings. If that withdrawal rate is sufficient to cover your income shortfall, then your current retirement plan is probably on track. If it will not be enough to cover your expenses, then you need to increase your retirement plan contributions. Also bear in mind that you may need to adjust your rate of withdrawal in some years depending upon how your portfolio is performing. If your investments are doing well, then you may be able to draw out a bit more, while drawing out less in down years.
Here's an example to show you how this process works.
Jim has $150,000 in retirement savings. He is 45 years old and plans to retire when he is 65. He estimates that his Social Security benefit will be about $1,350 per month. He currently earns $70,000 a year at his job, contributes 10% of his pay into his 401(k) plan, and receives a 50% matching contribution from his employer. He estimates that his monthly expenses in retirement will be about $4,000. His retirement savings have grown by an average of 7% each year, and a financial calculator shows that if they maintain those returns, they will grow to just over $1 million in 20 years. A withdrawal rate of 4% will bring him income of $41,082 per year, or $3,423 per month. Including Social Security, his total income per month comes to $4,774. He is largely on track with his retirement savings, as his estimated monthly expenses are $774 lower than his forecast income.
Now is the time for you to figure out how much money you'll need to retire in dignity and security. If you're still unsure of whether your retirement plan is on track after you taking the steps shown above, then you should consult with a financial planner for further assistance.
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