Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.
There are a few common ways to estimate how much money you’ll need to retire — for example, some financial advisors recommend saving 25 times your expected annual retirement expenses. Accurately forecasting your expected expenses after retirement is an important element of the planning process. While Social Security and pension payments can help complement your retirement savings, it’s crucial to save up enough to ensure you can exit the workforce and enjoy your golden years.
Read on for tips on figuring out how much to save for retirement, as well as ways to determine if you’re saving enough for retirement currently.
How much would you like to invest?
Here are some of the most popular ways to estimate how much to save for retirement.
Perhaps the simplest way to calculate retirement savings is to estimate your annual retirement expenses and multiply that number by 25 for a rough approximation of how much you’ll need to be able to comfortably retire. Given the likelihood that your retirement portfolio will continue to appreciate in value over the course of your retirement, you’d have enough money to live within that estimate for longer than 25 years.
Suppose you calculate that you’ll need no more than $50,000 per year to live comfortably during your retirement — the 25x rule would suggest that you need $1.25 million by your retirement date. If the rate of return on your retirement portfolio exceeds 4%, your funds would increase year over year.
The 4% rule is a strategy designed to ensure that your retirement savings will last over a long period of time. According to the 4% rule, you should withdraw no more than 4% of your total savings during your first year of retirement, then adjust that amount based on inflation for each subsequent year.
Hypothetically, if you had $1.5 million in retirement savings, you could withdraw up to $60,000 in the first year of your retirement. If inflation holds steady at 2%, you’d withdraw up to $61,200 the next year, $62,424 the year after, and so on. Depending on the rate of inflation and your retirement portfolio performance, the rate of return on your nest egg could exceed your yearly withdrawals.
This strategy is predicated on a steady rate of inflation, but inflation has been falling short of the 2% target for this rule for several years. If the inflation rate is low, that 4% number could be adjusted upward.
The 80% income rule is perhaps the most restrictive rule in terms of limiting retirement spending, depending on how much you think you may need on an annual basis once you retire. The 80% rule posits that you should only be spending 80% of your pre-retirement annual income per year after you retire — so if you had a salary of $100,000, you should only budget for $80,000 annually after you exit the workforce.
Even with this plan, you’ll need to forecast your expected retirement date and budget enough so your savings can last you a few decades once you retire. If you’re planning to retire at age 60, three decades worth of retirement would cost you $2.4 million at $80,000 per year.
There are tax advantages that come with utilizing certain types of savings accounts designed for retirement savings.
The most commonly offered employer-sponsored retirement savings plan, the 401(k), is financed with automatic, pretax withdrawals from an employee’s paycheck. That money is invested at the employee’s discretion from a list of available funds, and many employers match their employees’ contributions up to a certain percentage.
That employer match effectively doubles the employee’s investment, even before the 401(k) grows in the stock market. Money can be withdrawn tax-free after the account holder turns 59 ½ years old. If you’re able, contribute the full amount needed to maximize your employer match.
Once you’ve maxed out your 401(k) contributions, there are other tax-advantaged strategies for making retirement savings contributions.
Traditional IRAs: People can open retirement accounts separately from their employers with a Traditional IRA, which are offered by many financial institutions. Much like a 401(k), IRAs allow people to make pretax contributions that can grow without being taxed. Traditional IRAs are taxed based on the person’s current income tax rate when they withdraw their funds in retirement. There are contribution limits though, and they are lower than those of 401(k) plans.
Roth IRAs: Roth IRAs are very similar to Traditional IRAs, but there are some key differences. With Roth IRAs, taxes aren’t deducted upfront, as contributions are funded with post-tax dollars, but this also means that withdrawals during retirement are tax-free. Roth IRAs are also only available to people below a certain income threshold in a given year. Otherwise, the contribution limits and basic account structure is the same as that of a Traditional IRA. Some people may prefer a Roth IRA if they think they’ll be in a higher tax bracket when they retire.
Brokerage or deposit accounts: There are plenty of financial institutions that offer brokerage accounts designed for retirement savings. Stock investments carry some risk, but investors often place a portion of their wealth in mutual funds and bonds to mitigate this. Deposit accounts like money market accounts and certificates of deposit (CDs) are also a stable way to keep your money safe in an FDIC-insured bank or NCUA-insured credit union.
It’s important to regularly check in on your retirement savings progress as you contribute to your 401(k) and other accounts. MagnifyMoney’s retirement savings calculator can help you determine how much money you’ll have saved up for retirement. This calculator won’t determine how much money you’ll need for retirement, but it can estimate how much money you’ll have when you hit your target retirement date. If you are want to speak to a professional about your savings pace talk to a financial advisor about how you can reach your ultimate retirement goals.
A common benchmark for determining whether you’re on track to save enough for retirement was created by the investment firm Fidelity. Its rule of thumb recommends saving at least:
You might also consider taking a look at your peers’ retirement savings progress to get an idea of how you compare. MagnifyMoney compiled a retirement savings study with information including the average U.S. household’s retirement savings by age.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.