Are You Saving Enough for Retirement?

Senior Couple Meeting with Financial Advisor.
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Are you saving enough money for retirement?

There are several theories about how to answer this question. I recommend walking through all of these exercises, so you'll get a broad idea about whether or not you're on-track.

If you run through all of these rules-of-thumb, and the majority give you a thumbs-up result (saying that you're on-track), you're probably okay. But if multiple litmus tests tell you that you're not on-track, it may be a warning sign that you should boost your retirement contributions.

With that said, let's take a look:

#1: Percentage

The first rule-of-thumb is simple: are you saving at least 15% of each paycheck in retirement accounts, like a 401k, 403b or IRA?

Remember that employer matches qualify towards this total. If your employer matches the first 5% of your contribution, for example, then you can save 10% of your income, your employer chips in another 5%, and you're saving a total of 15%.

#2: Replace 70 to 85 Percent

A popular rule-of-thumb is that you should be able to replace 70 to 85 percent of your current income in retirement. If you and your spouse earn $100,000 combined, for example, you should generate $70,000 to $85,000 each year in retirement.

Admittedly, this is a flawed rule-of-thumb, as it hinges on the assumption that your spending (expenses) are closely correlated to your income. (The unstated premise is that you're spending most of what you make).

I recommend modifying this tactic, by scrutinizing your current expenses. Which leads to the next tip ...

#3: Estimate via Your Current Spending

Another way to approach this: estimate how much money you'll need in retirement.

Start by looking at your current spending. This is a close approximation of how much money (in inflation-adjusted dollars) you'll want to spend in retirement.

Yes, you have expenses today that you won't have in retirement, such as your mortgage. (Ideally that will be paid off by the time you retire). But you'll also have retirement costs that you don't carry today, like certain out-of-pocket health and end-of-life care costs. And ideally, you'll also travel more, enjoy more hobbies, and indulge a bit.

As a result, you may want to budget for retirement by assuming you'll spend roughly the same amount you spend now.

Let's walk through an example, to illustrate this. Let's assume that you and your spouse currently spend $60,000 per year (regardless of your income), and that you would like to live on a budget of $60,000 per year during retirement.

Your next step is to look at your expected Social Security payouts, which you can obtain from the Social Security Administration website. This agency will show you how much money you're on-track to receive. You can also use the Estimator tool on the SSA website if you can't login to your personal account.

Let's assume you're primed to get $20,000 per year from SSA. This means you'll need a retirement portfolio that can create the other $40,000 annually (to reach a $60,000 total).

To generate $40,000 per year, you'll need at least $1 million in your portfolio. This allows you to withdraw the portfolio at a rate of 4 percent annually, which is typically regarded as a safe withdrawal rate.

Perfect. Now you know your target goal.

Use an online retirement calculator to see if your current contributions are putting you on-track to build a $1 million portfolio. If it's not, then you'll need to invest more in your retirement accounts.

(Here's an article that walks through certain milestones. If you save $2,500 per month, for example, in a tax-deferred account that grows at a 7 percent annualized rate, you'll be a millionaire in 17 years. If you can only save $400 per month, it'll take you 39 years to create that million.) 

Final Thoughts

Are you saving enough for retirement? If you're setting aside at least 15 percent of your income, then the short-and-easy answer is yes.

But to get a more comprehensive idea of whether or not you're saving enough, estimate your costs during retirement, then get an idea of how much of those costs need to be generated from your investment portfolio. Then simply look at whether or not your contributions are putting you on-track to generate this money from your portfolio.

If you're worried that you're not saving enough, it never hurts to boost your contributions just a little. If nothing else, the extra savings will give you added peace-of-mind.