Do you remember when a million dollars used to be the gold standard for the amount to have saved at retirement?
Well, as we all know, a million dollars is not what it used to be!
Knowing how much you need to save is certainly important, but your target should not be arbitrary. It could be one million, five million, or ten million dollars.
So where should you begin?
Before you set a target number to save, the first thing you may want to ask yourself is: what kind of retirement are you aiming for? In other words, what kind of lifestyle do you want to have in retirement? This is the biggest unknown that my planning clients wrestle with.
Rules of Thumb
Retirement experts have offered various rules of thumb about how much you need to save: somewhere near $1 million, 80% to 90% of your annual pre-retirement income, or 12 times your pre-retirement salary. Extensive studies have concluded there are safe withdrawal rates from an investment portfolio. And I’ve written about this previously (updating with some more antidotes now).
One common way we check to see if someone is “on the right track” is by using the below diagram from Fidelity. It uses your salary at certain ages and uses a multiplier to see if you have accumulated that much. Take a look and see if you are there (or not):
Of late, I’ve seen a popular push towards the “25x Rule”. This is a simple and easy rule to understand how much you might want to have to live off in retirement.
You take the amount you wish to spend annually in retirement and multiply it by 25. A simplified example: if you want to have $75,000 to spend each year in retirement, you multiply it by 25 (so build up a $1,875,000 nest egg). This should last about 30 years in retirement. Think about saving e a little more if you plan on living longer.
Here’s another numerical example, compiled from research at Bank of America:
But what’s right for you? And how do you know you’re on track?
There are so many variables, even expert researchers cannot agree on a dollar amount.
Family longevity certainly comes into play. Age, health, quality of life, and unexpected consequences will all be factors.
It’s best to come up with an estimate of what you think you will be spending annually. Some people like to split retirement into 3 phases: the GO-GO years, the SLOW-GO years, then the NO-GO years. As you get older, your spending needs change in each of these phases. Here’s a chart showing these 3 phases (columns) and how people tend to spend their money in each of those time periods:
Here’s What Makes You Live Longer
It’s commonly known that the #1 worry of retirees is running out of money. So is it any wonder that people who have income guaranteed for life tend to live a longer and happier life? Yes – guaranteed income (pensions, annuities, social security, etc.) have proven to increase satisfaction in retirement.
True indeed. When people have no money worries, it removes a great deal of stress from their everyday life. I am not turning this into an annuity sales pitch, but income annuities do serve a purpose and should be considered. They can complement other sources of income you may have. I know that when I am in retirement, I’m going to do my best to live and collect every possible paycheck that I can!
We’ve heard this word before, and definitely of late. INFLATION.
In other words, how much will that lifestyle cost you in future dollars? The term “Future dollars” is key, because the same lifestyle today will cost significantly more in 20 years. For example, if your ideal retirement costs you $100,000 today, that same lifestyle will cost $180,611 in 20 years, assuming 3% inflation.
Once you’ve put a price tag on the annual cost of your lifestyle at retirement, the next question is: how many years will you be retired? Said differently, “How long are you going to live?”
Obviously, none of us can know for sure just how long we’ll live, and family history may not be the best guide. According to the Society of Actuaries, because of medical technology and healthier habits, many couples retiring today may have a 50% chance of at least one of them living into their 90s.
To be conservative, if you retire at 65, you may want to plan for at least 30 years of a cash need. I almost demand that my client plan to live to age 100…if not longer (BTW I plan on living to 120).
By addressing how much your retirement lifestyle will cost and adjusting for inflation and longevity, you’ll be ahead of most. You will then be better able to answer the question of how much you need to save. If you need to save more, even a 1% increase can equate to a lot over time.
If you love crunching numbers and have a financial calculator, try it yourself. You can come up with a pretty accurate estimate of how much you should be saving each year to be ready for retirement. As part of our financial planning process, we use sophisticated modeling software. This enables us to stress-test the feasibility of meeting your goals with different savings rates.
If you’d like to walk through your personal situation and how much to save for your retirement, send me a note!