You’ll need to do some serious thinking about retirement to come up with the right savings strategy.
One of the trickiest aspects of setting money aside for retirement is figuring out how much to save. Some people will tell you that if you part with 10% of your salary year after year, you’re good. Others will tell you that 15% to 20% of your income is more appropriate.
In the course of building your nest egg, it’s important to think about replacement income — meaning, what percentage of your salary today will you need to get by as a retiree? It’s a hard number to narrow down.
Many financial experts insist that 70% to 80% is the benchmark to follow. But the reality is that your need for replacement income may be very different.
It’s all about your lifestyle choices
It’s easy to see why 70% to 80% replacement income tends to be the guideline of choice. Once you’re retired, your expenses are likely to decrease to some extent, because at the very least, you won’t be paying to commute to a job. You may also, at that point, have a paid-off home, which means you won’t have a mortgage to cover.
Another obvious reason you’ll need less money in retirement is that you’ll no longer have to worry about saving for retirement. If 10% of your paycheck goes toward your 401(k) or IRA now, then it stands to reason that’s money you won’t have to part with for that purpose once you’re no longer working.
But while the 70% to 80% replacement income range is a reasonable one to use as a starting point, it may not be the optimal range for you. It may be that you’re expecting to live very frugally as a retiree. That could mean relocating to an inexpensive area, growing as much of your own food as possible, and generally staying close to home. In that situation, you may be just fine living off 50% to 60% of your current paycheck.
Then there’s the opposite end of the spectrum. Maybe your goal in retirement is to travel a lot because you never really had time to do it during your working years — perhaps due to a demanding career. In that case, you may need 90% to 100% replacement income if you’re anticipating a lot of costly trips.
Try to think things through ahead of time
It’s hard to establish a retirement picture in your 20s or 30s, when that milestone is so far away. But the sooner in life you are able to decide what you want retirement to look like, the sooner you can establish a savings goal that’s based on the amount of replacement income you’re hoping to have.
Let’s say you earn $100,000 a year now and think you’ll need $90,000 a year in retirement. Let’s also assume you expect $30,000 of that to come from Social Security. That means your nest egg will need to provide you with $60,000 a year. Assuming a 4% annual withdrawal rate, that leaves you with a savings target of $1.5 million.
Of course, you might also end up adjusting your retirement lifestyle based on the amount of income you have available. The key, though, is to try to think about what you want out of retirement ahead of time so you can set yourself up for the lifestyle you’re aiming for.
