However, there are several factors to consider, and not all of your income will need to come from savings. With that in mind, here's a guide to help calculate how much money you will need to retire.
It's not about money, it's about income
One important point when it comes to determining your retirement "number" is that it isn't about deciding on a certain amount of savings. For example, the most common retirement goal among Americans is a $1 million nest egg. But this is faulty logic.
The most important factor in determining how much you need to retire is whether you'll have enough money to create the income you need to support your desired quality of life after you retire.
Will a $1 million savings balance allow you to create enough income forever? Maybe, but maybe not. That's what we're going to determine in this article.
How much income do you need to retire?
How much income do you need to retire?The reason you don't need to replace 100% of your pre-retirement income is that, when you retire, you're typically able to eliminate certain expenses. For example:
Social Security, pensions, and other reliable income sources
Social Security, pensions, and other reliable income sources
The good news is that, if you're like most people, you'll get some help from sources other than your savings, such as your Social Security benefits. For most people, Social Security is a significant income source.But the percentage of income that Social Security will replace is typically lower for higher-income retirees. For example, Fidelity estimates that someone earning $50,000 per year can expect Social Security to replace 35% of their income. But someone earning $300,000 per year would have a Social Security income replacement rate of just 11% on average.
If you have any pensions from current or former jobs, be sure to take those into consideration. The same goes for any other predictable and permanent sources of income. For example, if you bought an annuity that kicks in after you retire, or you’re tapping your home equity through a reverse mortgage.
How much savings will you need to retire?
How much savings will you need to retire?Now let's determine how much savings you'll need to retire. After you've figured out how much income you'll need to generate from your savings, the next step is to calculate how large your retirement nest egg needs to be for you to produce this much income in perpetuity.
We saw in the previous section that our couple would need $4,000 per month ($48,000 per year) from their savings. So, in this case, they should aim for $1.2 million in retirement savings accounts, such as a 401(k) plan or individual retirement account (IRA), to provide $48,000 per year in sustainable retirement income.
It's important to note that the 4% rule has a number of flaws. It assumes you'll withdraw the same amount each year in retirement, adjusted for inflation. It also assumes that your portfolio will be split between stocks and bonds throughout your retirement.
In some circumstances, you may want to withdraw significantly more or less than the standard 4%. For example, as of mid-September 2023, the S&P 500 index is up about 15% for the year to date. During a stock market correction or a bear market, you may want to limit your withdrawals to give your investments time to rebound.Regardless of your retirement goals, recent stock market volatility shows just how essential it is for retirees to have some cash on hand. This can act as a buffer for your portfolio by helping you avoid cashing out on investments while the market is still down.
The bottom line on retirement savings goalsThere is no perfect method of calculating your retirement savings target. Investment performance will vary over time, and it can be difficult to accurately project your actual income needs.
Furthermore, it's worth mentioning that not all retirement plans are equal when it comes to income. Money you withdraw from a traditional IRA or 401(k) will be considered taxable income. On the other hand, any money you withdraw from a Roth IRA or Roth 401(k) is generally not taxable at all, which may change the calculation a bit.
It's also important to consider the impact of inflation on your retirement plans. Inflation has gotten a lot of attention in 2023 as prices have increased at the fastest pace we've seen in 40 years.But even when costs rise at a typical rate, inflation hits senior households harder than working-age households. That's because seniors spend a higher portion of their incomes on expenses such as healthcare and housing. These expenses tend to increase faster than the overall inflation rate.
Related retirement topics
Working While on Social SecurityWorking and collecting Social Security benefits? It gets complicated.
Full Retirement Age for Getting Social SecurityWhen can you retire and collect Social Security? It depends on when you were born.
While we're trying to present the broad strokes here, it's still a good idea to consult a financial advisor who can tailor a retirement savings goal to your particular situation and also help to set you on the right path with a savings and investment plan that can make sure you reach your goals.
David C. John, MA, MBA,
The Motley Fool: What is your advice for someone who may be worried about retiring because of recent financial setbacks?
David John: If your health, family responsibilities, and job status allows, continue to work longer than you might have before. The extra time allows you to save more and for the markets to continue to recover from past losses. Most important, delay taking your Social Security for as long as possible so you'll have a larger, inflation-protected benefit.
The Motley Fool: There are no hard and fast rules about when to retire or how much we should have saved, but what three pieces of advice would you give someone who is just starting their first retirement savings account?
- Make saving a priority and contribute a consistent percentage of your income that grows over time every payday.
- Invest only in a diversified option like a target date fund that uses passive index funds. Don't try to beat the market with your retirement money.
- Don't take a withdrawal unless you absolutely have to. Instead, start a separate emergency fund in addition to your retirement account.