One of the most difficult truths of retirement planning is that you will never get it right. Just as today’s retirees could never have foreseen the pandemic and the recession that we are experiencing, there will be surprises that will arise for you in your old age, some of which may cost you a lot of money that you did not budget.
The key to successful retirement planning is not to do things exactly the right way, but to get as close as possible based on well-founded assumptions and to err by making too high rather than too low estimates. If you’re still not sure how much you need to retire, follow the steps below.
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Estimate your retirement duration
To estimate how long your retirement will last (and, consequently, how many years of living expenses you will have to cover), you need to know when you plan to retire and how long you expect to live. You can choose any retirement date you would like to start with, but if, after looking at the numbers, you find that your plan is not viable, you may need to postpone retirement to have more time to save.
As for life expectancy, it’s a long shot, but you can use your family history and your own lifestyle as a starting point. You can also try a life expectancy calculator, like this one from the Social Security Administration. It costs nothing to add a small pillow to your estimate, especially if you are a healthy person. I always assume that I will live for my 90 years, at least. It may not happen, but I would rather save some extra money and pass it on to my heirs than survive my estimate and not be able to pay my expenses.
Once you have these two pieces of information, calculating your retirement duration is as simple as subtracting your chosen retirement age from your estimated life expectancy.
Determine how much you will spend annually on retirement
Estimating your retirement expenses is a little easier than estimating how long your retirement will last, because you already have a baseline for your expenses. You know how much you spend monthly now. Or, if not, you can find out without much effort by reviewing your bank and credit card statements. Calculating your annual expenses is as simple as multiplying that by 12 and adding a little more for one-time costs.
Your retirement expenses will not be exactly the same as today because your life is likely to change between now and then. Taking care of children can cost a lot of money today, but in retirement, this is generally not something most people have to deal with anymore. You will also not have to budget money for retirement savings during retirement.
But other expenses may increase. Retirement generally brings more free time, which many opt for hobbies, but which can also bring new expenses. You can also choose to donate more money to important causes for retirement and you may have to spend more on health.
You can use your current expenses as a basis, but adjust each spending category up or down based on how you think your spending will change in retirement.
Estimate money from other sources
Although pensions are not as common today as they used to be, they still exist. If you have one, it can go a long way towards covering your retirement expenses, reducing how much you need to save on your own.
Some employers also match their employees’ 401 (k) contributions. This can also help you reach your savings goal more quickly, assuming you are contributing enough to your 401 (k) to win the mail in the first place.
Then there is Social Security. You can find out if you are eligible for this and estimate your monthly benefit by creating an account with my Social Security. This may not be perfectly accurate, because Social Security trust funds are expected to run out by the end of the decade, which can lead to benefit cuts. But the program will not end, and even if you receive only 75% of what is eligible based on the current benefits formula, it can still add up to hundreds of thousands of dollars over your lifetime.
Write down the money you expect from the above sources, as well as any other revenue streams you expect to have on retirement, such as rental income. This will help to reduce how much you need to save on your own.
Put it all together
Once you have all the pieces, you should combine them to get an accurate idea of what you should save for retirement. You cannot simply multiply your estimated annual retirement expenses by the number of years of your retirement, because you also need to account for inflation. Most retirement savings formulas use 3% a year for this, but you can go even higher if you want to be conservative.
A retirement calculator is probably the easiest way for the average person to estimate retirement needs, because it does a lot of math. You just fill in the various fields with details about when you plan to retire, how much you think you will spend, how long you think you will live, and the money you expect from other sources.
There are also places where you can enter how much you currently save and how much you save per month, so you can see if you’re on track for your goal. Remember, if you have your money in a retirement account, it is invested in assets that, hopefully, will increase in value over time. Your rate of return will dictate how many investment gains you will make, and retirement calculators have a place where you can enter this. It is best to use an estimate of 5% or 6%. While it is possible for your savings to grow faster than that, being conservative here will reduce the risk of retiring with very little.
In revision
Your retirement calculator should tell you how much you should save per month to retire whenever you want. If this is not feasible, the easiest ways to correct this problem are to increase the economy, if possible, or to postpone retirement. The latter gives you more time to save and shortens the duration (and cost) of your retirement at the same time. Keep making adjustments until you have a plan that works for you.
Then run your calculations again every year or two to make sure you’re on the right track. If your investments are performing better than expected, you can advance your retirement date. Or you may have to move it back if your investments have not grown as quickly as you thought.
You can also change your mind about how you want to spend retirement, so you need to be flexible. By reviewing your plan annually, you can make small changes instead of trying to figure out how to earn tens of thousands of dollars more on the eve of retirement.