One of the hardest parts of retirement planning is determining how much money you should save. Employer-sponsored retirement plans, investments, and Social Security are the three most common options.
Determining Your Needs Based on Current Income
Using current income to determine retirement needs is not helpful for those in the early stages of their careers. If you are in your twenties or thirties, you are likely earning an average or median income in your field. Your income may dip for a while if you change your career path, and this will affect your saving formula. It becomes difficult to predict how much you will need during your later years if you are unsure of your income before retirement over the years.
What If You Are a Saver?
Another problem with the income replacement rule is that it assumes you spend most of your income. It assumes you spend 70% to 85% of your income if you save 10% to 15% for retirement, and perhaps another 10% to 15% for other types of non-retirement savings.
People do not always spend most of what they earn. In fact, some spend more than they earn, resulting in credit card debt, while others spend much less than they earn. This is another reason why basing retirement predictions on past income (rather than future expenses) is not the best framework for planning.
Focusing on Spending Rather than Income
It is wise to base retirement predictions on your spending level, not on your income.
The Bureau of Labor Statistics reported a 5.4% increase in income and a 7.8% increase in expenditures in its 2019 Consumer Expenditure Survey, before the financial effects of the 2020 pandemic. Spending on transportation saw the largest percentage increase at 10.1%. Spending on entertainment declined by 4.2%, and spending on personal insurance and pensions decreased by 1.8%.
The spending you will incur during retirement is likely to be different from your current spending. You may not have a loan payment at that time. Your children may grow up and live on their own, so you won’t have to support them then. You will also stop incurring work-related costs, such as childcare, work attire, and commuting expenses.
However, while you will incur other costs that you may not need to support now. Your prescription costs may become a larger concern during the post-work period. You may also want to delegate household tasks that you currently do yourself, such as cleaning surfaces and taking out the trash. You may choose to travel more or use retirement to explore hobbies that you couldn’t focus on during your working years.
Income is not an ideal foundation for determining how much money you should keep in savings for retirement. Expenses are not a great option either. But expenses may be a better benchmark for the amount you should target. Some of your current expenses will decrease, but some others will grow, so it makes sense to expect that what you are spending now will be at least close to what you will spend during retirement years.
Multiply Your Current Annual Spending by 25
Here is a general rule you can use to calculate how much money you will need at retirement: multiply your current annual spending by 25. This is the amount you should have in savings to enable you to withdraw 4% from that amount each year to live on.
You will need an investment portfolio amounting to 25 times $40,000 a year – $1 million at the start of retirement if you are spending $40,000 a year now. This amount allows you to withdraw 4% in the first year of retirement, and the same 4% percentage adjusted for inflation in each subsequent year. You will maintain a good chance of not depleting your funds.
You can
Building a portfolio worth $1 million is possible even on a salary of $30,000 to $40,000, as long as you start saving at an early age, beginning in your early twenties.
If you started saving late
Don’t despair if you began saving late in life. The best way to make up for a late start is to save aggressively.
The older you get, the more you need to save and diversify your investments for retirement every month. Do not allocate a large percentage of savings to stocks with the idea that you need riskier investments to make up for lost decades of saving.
Risk accommodates both ways. You won’t have enough time to recover losses if your investments run into trouble.
Use index funds. Look for funds that charge low fees. Spread your money among a variety of stocks and bonds. Keep doing this throughout your working years, aiming to save 25 times your current spending level by the time you retire.
Use a retirement calculator to ensure you’re on the right track. Ignore the scary headlines in financial news. You’re playing a long game. Getting caught up in the daily ups and downs of the market won’t accelerate your progress.
Focus on ways you can increase your income or cut your expenses if you are starting to save late for retirement. A combination of both is ideal.
Redefining Retirement
The Bureau of Labor Statistics indicates that the workforce will grow to about 164 million people by 2024. This number includes about 41 million people aged 55 and over, and it is expected that the number of those aged 65 and over will reach 13 million people. People are working later in life for many reasons. Consider several options before you retire “officially” if you started saving late and need to earn more to close the gap between what you need and what you have.
It may make sense to stay on the job and take advantage of matching employer contributions in addition to the extra contributions through your 401(k) retirement savings plan if you enjoy your work. You will also be able to retain your other benefits longer.
You can take on consulting contracts for several years on a part-time basis while your nest egg continues to grow, or start a second career in a field you’ve always been passionate about. Embark on a new journey in a new field for a few more years if stepping away from a salary allows you to stay on track to meet your savings needs.
Redefining Your Lifestyle
You may not have started saving late, but you cannot afford the extra money to build a portfolio that reflects your current spending level. You may need to redefine the type of lifestyle you wish to live when you retire. There are many ways to cut costs and maintain an active lifestyle.
It might make sense to move to a smaller home. Live in a state that doesn’t tax income rather than keeping the home you currently own. You can take it a step further and live somewhere overseas where the cost of living is lower.
There are many ways to make retirement work. You just have to play with the numbers to figure out what works best for you. Save what you can, even if you don’t expect your retirement portfolio to reach $1 million, and adjust your habits to fit your lifestyle.
Frequently Asked Questions (FAQs)
How much money does the average person need to retire?
When
Thinking about the amount of money you’ll need for retirement, it’s important to remember the 80% rule. The 80% rule states that you should replace 80% of your pre-retirement income. If you’re earning $100,000 annually before retirement, you’ll need about $80,000 in annual withdrawals during retirement.
What percentage of my income should I put into retirement savings?
It’s recommended to save at least 15% of your pre-tax income in a retirement savings account or 401(k). The percentage you set aside for retirement can vary based on your personal circumstances, including how much you’ll need during retirement and how much you can afford to save each month. You can always use a retirement calculator to help estimate how much you’ll need in addition to Social Security.
Source: https://www.thebalancemoney.com/how-to-calculate-your-retirement-needs-4061547
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