Saving for retirement is what I consider the granddaddy of all financial goals because it typically requires a huge nest egg. But planning how much you really need to save in order to have enough to retire is more like an art than a science.
I think about retirement as a big party you’re planning when you don’t know exactly when or where it will be, how many people will show up, or how long it will last. There are many variables, which means there isn’t a one-size-fits-all answer for how much you should have.
Despite how confusing retirement planning may seem, I’ll make it simple by explaining where retirement income comes from and how much money you’ll need.
How Much Income You Need in Retirement
The whole point of saving for retirement is so you can continue enjoying a good lifestyle even after you stop working. Most people reach an age when they’re ready to slow down or they’re unable to work due to poor physical or mental health.
Having a secure retirement means you have enough in savings to preserve your pre-retirement income or standard of living. You’ll probably want to buy the same food, shop for clothes in similar stores, and enjoy the same hobbies. You might downsize to a less expensive home or have lower transportation expenses, but other costs, such as medical bills and travel, could go up.
A common target is to have 70% to 80% of your pre-retirement income after you stop working. For instance, if you earn an average of $100,000 in the years leading up to retirement, you might need a minimum of $70,000 to enjoy a similar lifestyle. However, the lower your income, the more difficult it may be to live on less in retirement.
My goal is to have no less than 90% of my income, and ideally 100%, in retirement. My expenses may drop in the future, but I’m not planning on reducing my standard of living by much.
If you have high aspirations for retirement, such as owning a second home or travelling extensively, there’s nothing wrong with planning for more than 100% of your pre-retirement income. Also, your future debt—such as a mortgage or student loans for a child’s college—should be taken into account.
Let’s cover typical sources for retirement income and how much you’ll need to make sure you don’t run out of money.
See also: 7 Micro Habits That Create Financial Success
Your Social Security Retirement Benefits
In the United States, most workers are eligible for Social Security retirement benefits. Social Security is a group of benefits that give income to those who are retired, disabled, or survive a relative who was receiving benefits.
The Social Security program is funded from payroll taxes and the self-employment tax. If you’re an employee, you may see the deduction listed on your paycheck as OASDI, which stands for old-age, survivors, and disability insurance.
To qualify for Social Security retirement benefits you must generally work a minimum of 10 years. The calculation for how much you’ll receive is based on the average of your highest 35 years of earnings. If you worked fewer than 35 years, the missing years are factored in as $0 income. And if you worked more, only your highest-earning years are considered.
The program taxes earnings up to an annual threshold, which has increased over time. For 2018, Social Security tax for employees is 6.2% of earnings up to $128,400. Your employer also pays an additional 6.2% on your behalf.
If you’re self-employed you pay into the system on your own, but you have to pay the full amount, or 12.4%, up to the same amount of annual income. If your income exceeds the annual threshold, it’s no longer taxed until the following year.
The retirement benefit you receive varies widely depending on how old you are when you take it. The full retirement age has gradually increased over time because we’re living longer. If you were born between 1937 and 1959, your full retirement age is 66. But if you were born in 1960 or later, you must wait until age 67.
However, no matter when you were born, you can elect to take an early retirement starting at age 62. Problem is, you receive a permanently reduced rate, so it’s not always the right decision.
Let’s say you earned more than the annual Social Security threshold for most of your career. If you fully retired this year at age 66, the maximum benefit would be $2,788 per month. But if you took early retirement, you’d only receive $2,158.
To increase your payout, you can delay retirement until age 70. If you took late retirement this year, the maximum benefit would be $3,698. That’s almost 33% more income per month for the rest of your life for waiting a few years to receive it. That’s a simple way to secure a more comfortable retirement.
Again, these monthly benefits reflect the maximum if you were a high earner throughout your entire career. If you’re a middle-class American who fully retired this year, you could expect a benefit in the neighborhood of $1,600 per month.
Once you reach age 25, Social Security statements are mailed out each year, about three months before your birthday. After you’ve worked long enough to qualify, the statement includes an estimate of your future income.
Remember that if you take time off from work, your benefit can go down, or if you get a raise or a second job, it can go up. Also, any earnings that don’t have Social Security taxes withheld won’t show up on your statement and be factored into your future benefits.
If you’re worried that the future of Social Security is in jeopardy, don’t be. It has a reserve fund to pay all benefits through 2031. Beyond that date, small policy changes—such as increasing the payroll and self-employment tax or increasing the annual income threshold—are all we’d need to raise revenue and keep the program healthy.
If you want to learn more about Social Security, go paperless, check your earnings history, and see your estimated future retirement income, create an online account at ssa.gov. Review your reported earnings for any errors because mistakes could keep you from receiving all the benefits you’re entitled to.
See also: Choose the Right Retirement Account in 3 Simple Steps
Your Personal Retirement Benefits
While having some amount of Social Security to rely on in retirement is great, it’s not going to be enough. The program was designed to be a safety net for unprepared retirees, not a sole source of income.
If you’re one of a declining number of employees who have a workplace pension, consider yourself fortunate. A typical pension pays in the neighborhood of 2% of your income for every year worked. For example, if you stay with your company for 20 years, your future benefit might be 40% of your pre-retirement income.
The majority of workers don’t have a pension, but have a retirement plan, such as a 401k or a 403b, instead. Pensions have fallen from favor because they’re very expensive. Offering a retirement plan costs companies much less because workers bear the burden of funding them, not employers.
If you don’t have a retirement plan at work, or you’re self-employed, there are a variety of options, such as an IRA, SEP-IRA, or solo 401k. Qualified retirement accounts offer tax benefits, which make it easier to save and build your nest egg faster.
How much income you can take from retirement accounts or other personal savings and investments depends on the balances when you retire. How much you’re able to accumulate depends on three main factors:
- How much you contribute
- Your account fees
- Your investment return
The only variable you have total control over is how much you contribute. I recommend saving a minimum of 10% to 15% of your gross income for retirement. Yes, it’s more difficult than parting with 2% or 3%, but making sacrifices to invest more will pay off.
While no one likes the idea of paying fees, they’re unavoidable. Companies that manage investments and administer accounts have lots of expenses to cover. All you can do is choose low-fee investments so they take as little of your earnings as possible.
Your investment return will vary depending on what types of investment you choose. My recommendation is to pick passively managed, low-cost funds, such as stock index funds. These highly diversified investments mirror the general performance of a particular stock market.
The value of index funds will go up and down in the short term; however, over time the market has increased. For example, from 1950 to 2018, the S&P 500 rose an average of 10.5%. You could accumulate a massive retirement account even if you earn less.
Young investors should typically own mostly stock funds because they give higher returns over the long term. There are also bond index funds, which are more conservative with lower returns. As you approach retirement, you’ll want to own less stock and more bonds to protect your account from potential losses.
Also see: 3 Excuses Keeping You from Saving (and How to Kill Them)
How Much Money Do You Really Need to Retire?
Most people need to accumulate about ten times their income to generate enough retirement income. So, if you earn $100,000, having $1 million is a wise goal.
Let’s say you earn $75,000 and want to retire at age 67 with 80% of your pre-retirement income, or $60,000. You can probably count on getting about $20,000 a year from Social Security and the remaining $40,000 must come from savings.
Assuming you’ll live 30 years after you retire, and continue earning a conservative rate of return on your nest egg, getting income equal to 5% per year is reasonable. If you divide your annual desired income by this rate, that’s a total required savings of $800,000 ($40,000 / .05 = $800,000).
As you can see, multiplying your pre-retirement income by ten, which comes to $750,000 ($75,000 x 10), gets you pretty close to the same number. But if you wanted to have 100% of your income (instead of 80%), you’d need about 14 times $75,000 in savings, or just over $1 million.
There are many unknowns, but using these basic calculations gives you a target savings number to shoot for. If you’re not on pace to have what you’ll need, it’s time to increase your savings rate.
One way to make sure you’re on track is to have a goal based on your age, such as saving:
- Your annual salary by age 30
- Two times your salary by age 40
- Four times your salary by age 50
- Eight times your salary by age 60
- 10 times your salary by age 66 to 67
As your income, debt, and lifestyle changes, reevaluate how much retirement income you’ll need and whether you’re saving enough to achieve it.
See also: 6 Essential Habits of Financially Healthy People
8 Factors That Affect How Much Savings You Need to Retire
Here’s a list of eight factors to consider when planning how much you’ll need for retirement.
1. Your retirement age – is critical because the earlier you need income, the more you’ll need to save. Most people use the age they’ll start receiving Social Security as a default. But if you accumulate a large nest egg, it’s possible to retire earlier.
2. How much you’ve saved already – plays a big role in how big your nest egg will be. The sooner you begin saving, the more compounding interest works in your favor to grow your balance.
3. Your average pre-retirement investment return – determines how quickly your balance can grow. For example, investing $200 a month for 40 years at a 3% return would grow to $185,000. But if you got an 8% return, you’d have $700,000.
4. Your post-retirement investment return – is also important because you need to keep your savings working for you once you're retired. However, to keep your nest egg safe, the best choice will be low-risk, low-return investments.
5. How much Social Security you’ll receive – or other income, such as a pension, is key for accurate retirement planning. For typical workers, Social Security may replace 30% of your pre-retirement income.
6. Inflation – causes prices to rise, which makes your retirement income less valuable. It’s good to know that Social Security retirement benefits are adjusted for inflation as the cost of living rises.
7. Your withdrawal rate – is how much money you take out of your nest egg each year. Many people believe they can live on less than their pre-retirement income. But if you dream of lavish trips, living in an expensive area, or believe you’ll need costly medical care, you may need more income in retirement.
8. Your longevity - is the biggest unknown when it comes to planning for retirement. If you’re relatively healthy at full retirement, statistics show that you’ll live into your late 80s. If you have a good family health history and take care of yourself, it's possible that you could need retirement income into your 90s.
If all these unknown variables for retirement planning make your head swim, here’s a simple solution: save no less than 15% of your gross income. Use tax-advantaged accounts—such a 401k, 403b, or IRA—to reduce your taxes and put away even more for your future financial security. You can download the Retirement Account Comparison Chart to learn more about which account is right for you and the best places to open one.
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