In the Federal Reserve’s latest Report on the Economic Well-Being of US Households, only 36% of non-retired adults felt like their retirement savings were on track. That means a whopping 64% of working adults are worried that they’re falling behind.
Perhaps you also have concerns that, at your current savings rate, you won’t have enough money saved to retire without having to dramatically lower your standard of living.
Are these fears warranted? Or could it be that we’re being too hard on ourselves when it comes to the retirement savings expectations we place upon ourselves? How much do you really need to retire? Here’s how to calculate your own retirement savings number.
How much money do you need to retire comfortably?
According to AARP, one common rule of thumb is that you’ll need 70% to 80% of your pre-retirement income after you retire. So if you made an average of $75,000 per year during your working years, you may only need $52,500 to $60,000 in retirement.
This 70% to 80% estimate is based on the likelihood that your expenses will be lower in retirement than during other phases of life. Student loan payments will hopefully be in the rearview mirror and your mortgage may be paid off as well. Plus, some (or all) of your kiddos may have already left the nest by the time you decide to retire.
But it’s important to understand that your personal retirement income needs could be different than these estimates. That math could look different, for example, if you’ll have a mortgage payment for several years of your retirement or you plan to do a lot of traveling. Depending on how much you plan to spend per year in retirement, you could need to replace 100% (or more) of your pre-retirement income.
How much do you need to save to hit your retirement income goals?
Once you’ve estimated your retirement income needs, it’s time to calculate how much money you need to save to hit that number. One popular way to do this is to use the 4% rule. This rule states that if you confine your retirement withdrawals to 4% of your total investments per year, you should never run out of money.
Using the 4% rule, if you wanted retirement income of $40,000, you’d need to have $1 million in your investment portfolio when you retire. If you think you’ll need $100,000 per year in retirement, you’d need to save $2.5 million.
A quick way to calculate how much you need to save to retire comfortably using the 4% rule is to multiply your desired annual income by 25. So if you want to live on $50,000 in retirement, you’d need to save $1.25 million ($50,000 x 25 = $1.25 million).
The 4% rule has received its fair share of criticism from investing experts and researchers. Some have pointed out that since bond yields are lower today than they were when the 4% rule was developed, it may not be realistic for investors moving forward.
Despite its limitations, the 4% rule is still a helpful tool for “ballparking” how much you need to save for retirement. But if you’re worried that you could run out of money by following it to the letter, feel free to choose a more conservative withdrawal rate or consider using a dynamic spending approach in retirement.
What additional income will you receive in retirement?
One of the downsides to the 4% rule is that it doesn’t take any sources of income into consideration other than investment returns. But there’s a good chance that you’ll have additional streams of income in retirement that can reduce how much you need to save.
First and foremost, you’ll want to consider your Social Security income. In December 2019, the average monthly Social Security benefit was $1,503. That’s $18,000 per year that the average person doesn’t need to pull from their retirement savings pot. To estimate your own Social Security income, you can use the Social Security Administration’s calculator.
Do you own a rental property? If so, you’ll want to take your rental income into account as you’re thinking through your retirement savings needs. And if you plan to do some part-time work after you retire from your primary career, that could significantly reduce how much you need to save as well.
Let’s say you plan to spend $65,000 per year in retirement. Using the 4% rule, you’d need to save $1,625,000 before you retire. But what if you know you’ll bring in $15,000 per year in additional income? That means your retirement investments only need to provide $50,000 of income per year instead of $65,000. And your retirement savings number would drop to $1,250,000 — that’s a $425,000 difference!
How much of your retirement income will be taxable?
Do you have any money saved in a post-tax retirement account like a Roth IRA? If so, that could also reduce how much you need to save to retire.
Since you pay taxes up front on Roth IRA contributions, withdrawals in retirement are made completely tax-free. Depending on your tax bracket in retirement, that could save you 10% to 37% in income taxes.
Social Security income comes with tax benefits as well. If your retirement income is less than $25,000 for an individual or $32,000 for a married couple, you won’t pay any taxes on Social Security benefits. Mid-range income earners may have up to 50% of their Social Security income taxed, while the most you can be taxed on is 85%. Learn more about how social security benefits are taxed.
The overall point is that there’s a good chance that one or more of your income streams in retirement could be tax-advantaged. And that can make a difference in how much you need to save to enjoy a comfortable retirement.
The bottom line
Everyone’s retirement income needs will be slightly different. To calculate your own retirement savings number, carefully think through your anticipated expenses and potential income streams. Or, if you’d like expert retirement guidance, you may want to consider setting up an appointment with a financial planner.
