Retirement is a goal that all working people share, but the timing varies significantly from person to person. The biggest factor in most people's decision about when to retire is the money they have saved in a retirement fund. Retire too early, without enough funds saved, and you may have to return to work or lower your standard of living.
So, when it comes to retirement savings, how much is enough? There may not be a definitive answer, but crunching some numbers can give you a ballpark idea. Here are some guidelines that can help shape your retirement planning.
Conflicting Rules of Thumb
Broadly speaking, there are two rules of thumb that people can use to establish rough retirement goals.
Based on Income
One of these rules suggests that you need to save enough money to live on 75% to 85% of your pre-retirement income. If you and your spouse jointly earn $100,000, for example, the two of you should plan to save enough money to have between $75,000 and $85,000 per year in retirement.
Based on Expenses
The second rule of thumb suggests that your expenses, not your income, should guide your retirement planning. Rather than set a figure corresponding to your current salary, this strategy requires you to figure out how much money you want to live on each year during retirement, then multiply by 25. That's how much you'll need to save.
For example, if you and your spouse decide to supplement your Social Security income with an additional $40,000 from your savings every year, you'll need a portfolio value of $1 million when you retire. If you and your spouse want to withdraw $80,000 a year, you'll need $2 million.
Questions to Help Calculate Your Expenses
While the first rule of thumb is fairly straight-forward—just take your current salary and calculate the percentage—the second rule of thumb will require a bit more work on your part. For the retirement goal to be helpful, you must accurately estimate how much money you'll need each year for your living expenses when you retire.
To start, look at your current budget. Your expenses in retirement may not mirror your current expenses exactly, but it'll give you a good starting point for your estimates. To make it more accurate, break down your budget by category, and consider how those categories could be affected by your retirement lifestyle.
Once you know your current budget, ask yourself the following questions.
Will Your Children Depend on Your Financial Support After You Retire?
Consider the cost of sending children to college and possibly supporting them through graduate school. Consider whether they're likely to ask to borrow money for a car, house, or engagement ring. Do you plan to pay for their wedding? These can add to your retirement expenses.
Amortize one-time expenses. If you plan to pay $20,000 for your child's wedding, for instance, assume that your annual retirement costs will be, on average, $2,000 per year higher than your current bills.
Are You and Your Spouse in Good Health?
Do you have family histories of major medical conditions that could prove to be expensive? Medicare handles some costs, but many seniors will pay out-of-pocket for some expenses. There are also "indirect" medical costs, like retrofitting your home to be wheelchair-friendly, which can cost a fortune. According to Fidelity's research, the average 65-year-old couple retiring in 2019 will spend $285,000 on health care costs throughout their retirement, and that's with the assumption that the couple is covered by Medicare.
Do You Have Debt?
Credit card debt, car loans, and student loans will all affect your budgeting. Assess your debt balances and their corresponding interest rates, then use that to estimate your timeline for paying down debt and how that'll affect your annual retirement budget.
Will You Have a Home Mortgage?
As you calculate your debt, don't forget about your mortgage. Determining how long you'll be paying a mortgage is a major factor in budgeting for your retirement.
What Are Your Home Costs?
Even if you've paid off your mortgage, you'll still have ongoing costs associated with homeownership. Look at your property tax rate and calculate those annual costs. Homeowners insurance is another ongoing cost you'll have to budget for.
Will You Care for Your Parents?
Do you or your spouse have elderly parents? They could need physical or financial assistance in their old age, so you should prepare to meet those needs.
Will You Care for Any Other Family Members?
If you anticipate needing to help siblings, cousins, or any other family members, you should budget for those costs.
Calculate Your Retirement Income
Understanding your sources of retirement income will help you better estimate how much savings you'll need to maintain your standard of living in retirement.
Your retirement income will be subtracted from your expenses as you plan your retirement budget. This income includes Social Security benefits, pension payments, and any income from rental properties, royalties, or annuities.
In 2019, less than one-third of Americans who were 65 or older received funds from a pension or retirement savings plan. If your job offers a pension plan, ask your employer for details about how much you'll receive. The human resources department is the best place to start asking.
Social Security mails out a form to Americans age 60 or older once a year, informing them how much they're eligible to receive in retirement, based on current contributions. Refer to that form to find your expected payment. If you can't find the form, use the estimator on the official Social Security website.
The Bottom Line
There's no substitute for hiring a financial planner who can take a close look at your unique situation and plan accordingly. That said, using a rule of thumb can give you a practical goal that you can work towards as you approach your golden years. You can base these ballpark goals off your current income or your expected expenses. What's important is that you start planning and saving well before you hope to leave the workforce for good.