Few people think about retirement until they need to think about retirement, only to discover there is just not enough to sustain their current lifestyle for 20 years or more. Whether you are 40 years away from retirement or 1 year away, it isn't something that can be ignored. No matter who you are or how much money you have, you can take these 4 simple steps to figure out your retirement plan and can also determine what, if any, external advice you'll need. Knock yourself out!
1. Estimate How Much Money You Plan to Spend Each Year for the rest of your life
How can you possibly know where to begin? Well, as a general rule of thumb, retirement planners estimate that you'll spend approximately 70% of the income you earned while you were working (example: if you're making $80,000 at retirement, you'll need about $56,000 per year). However, it should be noted that major expenses and debts MUST be paid off for this rule to work. If you're paying off a mortgage, you have high medical bills, you have expensive hobbies, or you're (God forbid) STILL paying off student loan debt, you may actually need to spend more in retirement than when you were working. A good way to determine if you can afford it is to create a hypothetical budget. Every individual is different: if your mortgage is paid off, but you plan to take multiple vacations per year, you may be able to afford these hobbies with some planning. It's also worth noting that senior couples tend to spend as much as $350,000 on medical care during retirement, so poor health may put a damper on may things.
2. Calculate How Much You'll Receive from Pensions and Social Security
Odds are you will receive supplemental income from one or more of these sources during retirement, if you were employed during your lifetime, and or if you paid taxes while self-employed. Many people look to Social Security in particular as their main source or their only source of income during retirement, and although it's a fixed amount, savings is the other half of the equation and it is the only one that you can control -- this includes money from your IRA, 401(k), 403(b), etc. because these are not constant amounts. You can determine how much money goes into these accounts at various stages in your career.
With inflation considered, you can use this calculator from the Social Security Administration to see just how much money you'll receive each month based on your current salary. You can view the amount of money in today's dollars or the projected dollars when inflation is factored. The difference is important and very significant. For example, $1,700 per month today may equate to the same value as $7,200 in the future.
If you're among the 13% of private-sector workers that has a defined-benefit pension plan, good for you! Be sure you talk to your HR contact to figure out how much the monthly payments will be.
3. Calculate the Difference
Here's the money you have coming in, here are your expenses, and the difference equals what you need to save now. Pretty simple. Not much else is needed to say for this step except that this can be done at any age. The longer you have until retirement, the better off you are to plan, obviously. It never hurts to have extra either, so this doesn't need to be completely scientific.
4. Make a Plan to Save Enough to Make up that Difference
Now that you know how much you need to make up the difference, this should be the focus of how much money you need to save for retirement. This makes it a lot easier than trying to pick a random number out of thin air. Many people look at their 401(k)s and think, 'Ohhhhh $100,000 is a lot of money, that will keep me going for years.' Maybe if you plan on dying a year after you retire, but what if you plan to live 20-40 more years?? This is why it's good to have an investments that generate enough income so that you don't need to take any money from the principal. An example of this would be stocks that pay dividends; if you can have a large enough investment to live off of the quarterly dividends paid out, or the interest generated by bonds, then you'll have a nice pocket of income to fall back on. This also involves figuring out how much principal you'll need to save in order to live off of the gains. For example, if your shortfall is $40,000 and you expect that your investments will generate 4.0% annually, take $40,000 divided by 0.04 to get $1.0 million. If you save a million dollars in investments, without returns included, this means you can live off of the annual gains without having to ever touch the principal - and that is precisely what you want. Too many people immediate tackle the principal only to watch it disappear slowly each year. A general rule of thumb is to not touch the principal on your retirement savings until you have about 30 years left.
As always, it never hurts to save more than you need, and you should also be mindful of how realistic this is for you to achieve on your own without a planner's aid. There are a lot of benefits to working with a financial planner, so in your retirement planning, be sure to keep an open mind.