“How much do I need to save for retirement? Give me my number.” This is what a client asked of me recently. Ah, wouldn’t life be easy if we knew exactly how much we needed to save? But that is a moving target with many variables. The various financial calculators and programs give an estimate but truth be told, retirement is to some extent unknowable.
Still, let’s take a crack at this.
1. Determine Your Retirement Expenses
Start by estimating how much you’ll spend annually in retirement. Consider the following categories:
- Essential Expenses: Housing, utilities, food, insurance, and health care.
- Discretionary Spending: Travel, hobbies, dining out, and entertainment.
- Inflation: Historically, inflation has averaged about 3% annually. Include this in your calculations.
A common rule of thumb is that retirees spend about 70%–80% of their pre-retirement income annually. However, this percentage can vary significantly depending on your desired lifestyle.
I prefer not to try to guesstimate the pre-retirement income amount too early as it can be an exercise in futility. For example, did 34-year-old me know that I would be running my own company? Not a chance. So if I based my retirement solely on my possible range of corporate earnings versus what I earn as an entrepreneur, I would be shooting low.
Likewise, 34-year-old me probably envisioned a large home. Here I am at 56, dreaming about a small condo or townhome, a simpler lifestyle where someone else does the yard work (goodbye, chainsaw and tractor!).
2. Estimate Your Retirement Duration
Your life expectancy will impact how long your retirement savings need to last. The average life expectancy is about 76 for men and 81 for women in the U.S., but many live longer. To be conservative, plan for a retirement lasting 25–30 years.
This may not be the most fun discussion I have with my 401k employees but it is necessary.
3. Account for Health Care Costs
Medical expenses tend to increase with age. Fidelity estimates that a 65-year-old couple retiring today will need about $315,000 for health care costs alone. This figure doesn’t include long-term care, which could add significant expenses.
And one can only hope for universal single payer healthcare.
4. Identify Your Income Sources
Evaluate your income streams during retirement, such as:
- Social Security: Understand your expected monthly benefit using the Social Security Administration's online calculator.
- Pensions: If you have one, factor in its monthly payout.
- Investments and Savings: Include income from 401(k)s, IRAs, brokerage accounts, and other investments.
- Passive Income: Consider rental properties, annuities, or royalties.
5. Apply the 4% Rule and realize its shortcomings
The 4% rule suggests that you withdraw 4% of your retirement portfolio annually to ensure your savings last for 30 years. For example, if you need $60,000 annually and Social Security covers $20,000, the remaining $40,000 must come from savings. Using the 4% rule, you’d need $1 million in savings ($40,000 ÷ 0.04).
I have debated the 4% rule with my colleagues as it falls apart pretty quickly under IRA RMD rules. Also, the 4% rule may overestimate how much money you need.
6. Adjust for Your Personal Situation
The 4% rule is a starting point, but it may not fit everyone. Factors like market conditions, unexpected expenses, or desires for larger withdrawals in early retirement may require you to adjust your plan. A more conservative withdrawal rate (e.g., 3%) might provide additional security.
For example, it is possible to buy a home in Detroit for $30,000. Yes, it might be a fixer-upper and I am sure it comes complete with two snow shovels. The average home price in San Francisco is $1,200,000.
And remember point #1, is it realistic that you will know where you want to retire in your 60s or 70s when you are only in your 30s? Experience and life have a way of shaping that discussion.
A parting thought
Start planning early, save consistently, and periodically review your plan to stay on track. Realize that life is full of curveballs and that it is hard to know definitively what the right answer is. And there may be multiple right answers.
And finally, as one wise industry wag noted, has the retirement plan industry, in its efforts to help Americans save “enough” for retirement, pushed goal posts that are higher than they need to be? And in that process, has the industry not only undermined the confidence in an ability to retire with dignity, but fostered what seems to be a pervasive sense that the retirement system is…a failure?
Focus on your situation and don’t let the popular press scare you. Only you know your situation and needs.