How Much Should You Be Saving for Retirement?

retirement-planHow much money do I need to retire? The question we all wish we knew how to answer. The reality is none of us really knows how long we’re going to be around so planning ahead for a stable financial future is fraught with variables.

Retirement planning is not just an issue of life span, either.  As we get older the medical bills can start to accumulate and you can bet that will make a big dent in your nest egg as time marches on.

Are you planning on sitting at home until you pass on or do you have some plans to enjoy your retirement that might involve travel, spending time with friends and family, or maybe pursuing a passion or a hobby? If so, you are going to need to save enough money to make those plans a reality. You have to take all of this into account when calculating how much you should be saving during your working years as well.  Naturally, this is only going to complicate your estimates.

So what is the answer, or better yet, how do you figure out a way to arrive at a realistic retirement savings number? The fact of the matter is that, despite all of your efforts to plan ahead, it still comes down to simple estimating and educated guesswork. That all begins with taking stock of your current financial situation and combining that with some careful thought about what your plans are during retirement.

Will your retirement entail a full and complete departure from the workforce or do you plan on maintaining some kind of employment, albeit in a much more reduced role but still bringing in an income? What about investments or other financial instruments that can generate additional income after you retire? Sure, you probably already started saving by now, but what are you relying on to build your wealth? Do you know what kind of taxes or fees, if any, you are facing when you start to access your funds? Will these investments continue bringing in money after you retire?

There are a lot of questions to answer in determining how much money you need to save for retirement.  While your answers today might change over time, they are relevant queries that need to be addressed and considered as you plan for your golden years.

Evaluate Current Finances

The first step to figuring out how much you will need to save for retirement is to examine your current monthly expenditures. You likely stick to a monthly budget in order to effectively and efficiently manage your money.  If so, then the good news is that you are already on your way to working through this step in the retirement savings process.

You’ll first want to start by reviewing your current budget and making a list of all your monthly expenses. Some of these items might fluctuate, so just go with an average estimate to account for it in your calculations.

When you have those numbers lined up, consider which of those will remain locked in going forward and which will increase (or decrease as the case may be). For instance, your average grocery bill, car insurance rates, and utility bills will probably remain relatively static.  However, if you are close to paying off your mortgage than the cost to live in your home will likely decrease.

After determining a rough estimate of your monthly expenses, you will then want to make another list to jot down your current income, assets and revenue streams. If you want to get serious about saving for retirement, then you’ll want to make sure that your current spending does not exceed your current income.  A comfortable retirement takes decades of planning and you cannot even begin to start saving if you are racking up debt instead of building wealth and assets.

On the other hand, if you see that you are spending less than you are currently earning, then your best bet is to immediately increase your monthly or quarterly deposits to your savings accounts. While we will soon drill down to find a more precise estimate for how much money you will need in retirement, always know that it is better to have more than you think you might need.

retirement-money-1307589-639x852Estimate Future Spending and Income

Next up, start to make a list of all the new activities you will be enjoying during your retirement and estimate how much money you’re going to need to act on those plans. Do you want to travel, take piano lessons, or take up woodworking as a new hobby?

Whatever you have your heart set on, make some estimates as to what those things are going to cost down the line. Be sure to also account for the fact that you are going to be aging during this time and healthcare costs are likely to become a more significant factor going forward.

Unfortunately, that likely means higher insurance premiums and additional out of pocket medical costs. You may have a clean bill of health at the moment which might make it tougher to get a fine point on what your health will cost later on.  Alternatively, you could already be managing some type of medical condition in which case you may be able to better estimate what your healthcare will cost down the line. Either way, be sure to include medical expenses into your expenditures total.

On your trusty notepad, combine whichever currently monthly expenses you will continue to incur during retirement (car insurance, grocery bills, utilities, etc.) with the estimated costs for your post-retirement activities.

You’ll next want to consider all of your current assets to estimate future income.  This includes your investment accounts, 401(k), real estate holdings, pension funds, or income from a new part-time job.

Once you have a round number of your current and future expenses, compare it to the number you calculated for your assets and potential future earnings. This is the first realistic glance of your financial outlook and what you see may delight or shock you. Which number is higher? Do your expenses far outshine your assets at the moment or is it the other way around? These numbers are going to have a tremendous effect on when and how you can plan for retirement.

Some of you may be mulling over an early retirement. In that case, your financial outlook may be considerably more positive and you’re just a few thousand dollars off the mark. You may only need to work another two or three years and you’re good to go.

For the rest of us, however, early retirement might not be in the cards. Instead, it’s back to making some long-term projections as to the realities that you are facing when it comes to saving for the future. To achieve your goals, you are going to need to get serious about a game-plan for your savings, make some wise moves when it comes to investments, and be sure not to let the government suck you dry with taxes and penalties.

Of course, the main determinant of when you can realistically retire is going to be predicated upon how much and how aggressively you’ve been saving. If you’re still not too sure on the amount you need to squirrel away, many financial experts have a general rule of thumb which they suggest you follow.

When in doubt, the number to have on hand when you are ready to retire is somewhere in the ballpark of 10 to 15 times your annual salary. That means if you are looking at retiring at the age of 62 and you are making about $85,000 a year, then you would need to have roughly $850,000 in the bank – on the low end. In fact, $1.2 million in savings would prove to be a far more comfortable retirement.

This is, of course, just an estimated figure. What you would require based on your situation and your goals might be drastically different and you may find that retirement is closer (or further) off based on your age and how much you have saved already.

Learning to Use the Retirement Calculator

Don’t worry if you’re still a bit lost or confused as to where to start or how to get to a number where you feel comfortable (or at least confident that your numbers are accurate).  Luckily there are a number of retirement calculators online that can help you with the mathematics of retirement. However, the only way that they will really be helpful is if you are true to yourself about your finances. So you might want to be conservative with the amounts that you can count on for income and estimate just a tad high on your expenses and other costs that will eat away at your nest egg.

Start playing around with the figures that you worked out for your assets and your projected future spending.  The calculator will give you the real dirt on how close (or far away) you are from retirement. They are designed to help take the guesswork out of the process as they are typically programmed to account for inflation, life expectancy averages, and other projections and benchmarks that you may not even think to consider when you are working through your numbers.

Just keep in mind however, these calculators are set to certain defaults that may not reflect your particular situation exactly. Your investment strategy may be more aggressive than what the retirement calculator is working from in terms of overall return on your money. The financial instruments that you are invested in will help you adjust accordingly. In addition, you may come from a family of extended lifespans, so you should keep that in mind when you are making your projections. If you can realistically count on living well into your 90’s based on how your relatives have fared, then you could be in for a long ride that will require your money to last longer than you might have thought at first.

You also need to account for your saving strategy up until this point.  If you started putting a little bit away here and there in your 20s, then not only am I impressed, but your financial situation will be more amenable towards retiring on the early side of your 60s instead of well beyond the average retirement age.

Combining all of these elements to paint a picture of your financial future is what a good retirement calculator is supposed to do and there are plenty of them that you can access by way of a simple Google search. Here are a few hypothetical scenarios that might reflect your current situation:

Let’s say you’re 27 years of age and you’re already started to think ahead and have saved $3,500 for your retirement. You’re earning an income of $45,000 a year and making a 10% contribution to your retirement fund. You will need $2,625 a month to stay at your current lifestyle through retirement, but at your current rate of savings you will only have $1,289 a month to work with.  That means you won’t be able to retire until the age of 72.

In another example let’s assume now you are 35 and are making $150,000 a year. You’ve got $55,000 in the bank and you are contributing 15% of your income to saving. That means you will need $8,125 a month to maintain the life to which you are accustomed and you will have $6,648 a month to live on. At this rate you are looking at retirement at the age of 70.

The bottom line here is simple – the earlier you start to put money away, the less you will need to actually save each month due to compound interest. While your interest is compounding so too are any potential fees that you may be required to pay on your investments and that could mean some serious money out of your pocket.

Understanding Compound Interest

Compound interest is really just like it sounds.  You are earning interest on your initial principle and on the interest that you are continuing to earn. Essentially, compound interest is the key to growing your nest egg exponentially in a shorter period of time.

The way it works is rather straightforward.  Your return is combined to the principal amount when each compounding period ends. For some savings accounts this can occur daily, for others it might be a monthly period. Whenever it takes place, the interest is determined and deposited into the account resulting in a larger balance and greater interest earned each time.

Savings Withdrawal

The purpose of saving for retirement is to make sure you have the means to live comfortably for the rest of your life once you exit the rat race. That means you need to determine the rate of withdrawal on the money you have saved so that you don’t spend it all before you shuffle off this mortal coil. To better prepare you for making your money last as long as it’s supposed to while you are still here, it’s important to figure out how much you can withdraw each year and still feel confident that your savings won’t run out.

Ask any financial guru and they will tell you that the average withdrawal is 4% annually over a period of 30 years. That means you can withdraw 4% of your savings from your nest egg each year, for the span of three decades, and you should be fine. It’s when the numbers change towards a longer lifespan that 4% could prove woefully insufficient.

If we’re using the example of 4% withdrawal over 30 years and you’ve put away $625,000 for retirement, then that breaks down to a retirement income of just $25,600 a year. Doesn’t sound like a lot of money, but then it could be perfectly suitable for the lifestyle you plan to live in retirement.

Double those numbers and when you have $1,250,000 in the bank that 4% savings withdrawal is $51,200 annually. That’s a lot better and it affords you the freedom to do more with your money and your life. Also, don’t forget the cost of living increases that are inevitable over time. That means your standard of living is going to cost more and that might require you to withdraw more than 4% as the years go by. That is something you are going to want to factor into your projections for withdrawal over the course of your lifespan in retirement.

retirement-401k-chalkboardPadding Your Retirement Amount

Maybe you’re looking at all of these facts and figures and you’re seeing the writing on the wall – you’re going to need to boost your savings for retirement. The good news is that you have some viable options available to help you reach your financial goals for the future. I’m not suggesting that it will be easy and, depending on how old you are and when you are aiming to retire, you might be facing some serious sacrifice and difficult choices. As you get older you will reach eligibility for benefits like Medicare and Social Security, both of which can play a role in helping you store away the money you need to get to the finish line.

For starters, you may need to tighten your belt a little and find the areas where you can reduce your monthly spending now so you can save more. Find ways to scrimp and save where you can.  Instead of spending money on dining out a lot you can put that money towards retirement and eat at home more. Cut your own lawn instead of paying that landscaping service to come over each week. Auditing your finances is the best way to get the ball rolling towards increasing your retirement amount.

Additional income is always going to be welcome.  If you need a little extra revenue, then get creative. That can include anything from selling things you no longer need or use to renting out a spare room that hasn’t been slept in for years. Maybe you have a discernible skill that you can exploit to make a little extra money on the side. This is in addition to the salary you will still be receiving from your employer plus any pensions or personal retirement accounts that are still accruing. Remember, if your employer does offer a 401(k) and even matches your contributions then you must make an effort to get as much as you can through that arrangement. The best money is free money and it’s even better if it comes from your employer.

Don’t forget about Social Security, but do be careful about when you start to take the payments from it. Everyone is eligible to collect once they reach the age of 62, but that DOES NOT mean you have to start withdrawing from it at that time. On the contrary, the longer you wait to get your checks the more you can receive in each one.

The minimum age to collect social security is 62, but the maximum is age 70. If you wait out those extra eight years, then every check will be 35% more than if you started collecting when you first became eligible.

The amount of each payout is determined by how much you put into the program during the course of all those years of employment.  If you delay taking your payments for another eight years you have at least some peace of mind that you can expect some routine, consistent income when you turn 70 and at a higher rate per payout to boot!

Just keep in mind though that if you trigger your payments before that time, let’s say around age 65, that the amount is locked in for good. They won’t increase as you get older despite the fact that you would have been able to collect more once you hit 70. Think about that when you really want to get your hands on that money.  If you are able to delay to the last possible year, then you will ultimately yield more of a return.

Our Final Thoughts

Before you do anything else, start to think about a plan for retirement. It can be very informal or extremely specific but start to consider these steps and devise a way to reach your financial goals for the future. Above all else, regardless of the path you choose towards retirement start ASAP. As we’ve seen, getting an early start on putting money away not only helps you build wealth more quickly, it also means you can put away less and still get to where you want to be in a reasonable amount of time.

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