Saving for retirement is probably the most complex of all financial goals (hence why there are countless books, articles and even radio shows on the topic). The challenge is in how many variables impact the outcome. In order to get a ballpark figure, you have to answer three big questions:
- What age do you plan to retire?
- How many years will your retirement savings need to support you?
- What kind of lifestyle do you want in your retirement (or stated another way, what expenses will you have)?
These are questions no one can answer definitively, but you can make educated guesses in a few different ways. One is by looking at statistics. For instance, the average reported retirement age in the US for 2014 is 62. Life expectancy for men in the US is 76, while it’s 81 for women. Using these numbers, a man would need to support himself for 14 years, a woman for 19. This is lower than what’s typically advised for planning’s sake because these are just averages. Many people will retire earlier or later and live longer or shorter than these estimates.
You can also set your retirement goals is by using some common rules of thumb:
Estimating your savings goal
- Your retirement savings goal should 8 times be your highest salary during your working years.
- Another way to calculate your savings goal is to determine how much you’ll need to live on annually after retirement and multiply by 25 (assuming you’ll live 25 years past your retirement age).
Setting your savings rate
- To keep yourself on track, you should save one times your annual salary by age 35, three times your salary by age 45, and five times your salary age 55, adjusted up as your salary increases over time.
- Most people should target to save 12-15% of their salary per year toward retirement, starting at age 25. If you’re starting later than that, you will likely need a higher annual savings rate to catch up.
Estimating your post-retirement spending
- You’ll need 70-80% of your pre-retirement salary to live comfortably, assuming you’ve paid off your mortgage and don’t have any foreseeable major expenses (like medical ones).
- You should not draw more than 4% of your savings per year after retirement for the risk of drawing down your principal balance, thus dwindling the possibility of future returns.
However, everyone’s specific situation is different. While it’s good to keep these rules of thumb in mind, the easiest way to get a personalized estimate is to use one of the many retirement calculators available online. This one from CNN Money is fairly simple, while this one from MSN Money is more detailed. Play around with the numbers to get a sense of your targets.
The final step is to calculate your annual savings rate, then figure out your monthly contribution. As an example, if you earn $50,000 annually and need to save 15% per year, that comes to $7,500. Divide that by 12, and your monthly savings goal will be $625. (This is assuming you don’t have an employer match; if you do, calculate that in, too.) As your salary increases, you’ll want to revisit this calculation and increase your monthly contribution.
Are there helpful tools you’ve found in planning for retirement? Share your thoughts in the comments below!
Please note: I am not a financial expert and speak to financial topics from my own personal experience. Please consult a financial professional before making any of your own personal financial decisions.