Retirement is one of the biggest financial milestones of your life. It’s a time when you can relax, enjoy the fruits of your labor, and finally live life on your terms. But to make sure you have enough money to support your lifestyle when you retire, you need to start planning—and accurately calculating how much you’ll need to save for retirement is a crucial first step.
Calculating your retirement savings isn’t just about guessing a number or throwing out a ballpark figure. It’s about taking into account several factors, such as your expected retirement age, lifestyle, healthcare costs, inflation, and more. By being thorough in your approach, you can ensure that you’ll have enough funds when it’s time to stop working.
Understand Your Retirement Goals
Before you start crunching numbers, it’s essential to know what you’re working toward. What does your ideal retirement look like? Do you plan to travel the world? Live modestly at home? Or perhaps a bit of both?
Defining your retirement lifestyle helps you estimate how much income you’ll need each month. So, first, ask yourself:
- How much do you expect to spend monthly in retirement?
- Will your spending change over time?
- What major expenses should you factor in, such as healthcare or long-term care?
Once you have a clear idea of what your retirement lifestyle will look like, you can estimate how much monthly income you’ll need. For example, if you want to live comfortably and plan on traveling a lot, your monthly expenses could be higher than someone who plans to stay at home more often.
How to Estimate Monthly Retirement Expenses
A good rule of thumb is that most retirees need around 70-80% of their pre-retirement income to maintain their standard of living. For example, if you currently live on $5,000 per month, you might need around $3,500 to $4,000 per month in retirement.
However, this is just a starting point. Some expenses, like your mortgage or child-related costs, may go away when you retire. On the flip side, things like healthcare, insurance, and travel might become more expensive as you age. Make sure to account for these changes in your budget.
Factor in Inflation
One of the biggest challenges when calculating your retirement savings needs is dealing with inflation. Over time, prices for goods and services tend to rise. A dollar today won’t be worth the same in 20, 30, or 40 years.
For instance, a $4,000 monthly living expense today could balloon to $8,000 or more over the course of 30 years. This means that you need to save more now to account for future inflation. The average inflation rate in the U.S. is typically around 2-3% annually, but this can fluctuate based on economic conditions.
Using an inflation calculator can help you project the future value of your current monthly expenses. For instance, if inflation is 3% annually, a $4,000 monthly expense would increase to $9,000 in 30 years.
Calculate Your Retirement Income Sources
Your retirement savings will come from various sources. The more diversified your income streams, the more secure your financial future will be.
1. Social Security
While Social Security is a vital source of income for many retirees, it’s not meant to replace all your pre-retirement income. On average, Social Security provides only about 40% of your pre-retirement income. So, it’s important not to rely on it as your sole source of funding.
To estimate how much you’ll receive from Social Security, you can use the Social Security Administration’s (SSA) online calculator. Remember, the amount you’ll receive depends on your work history and how much you’ve paid into the system.
2. Employer-Sponsored Retirement Plans
Employer-sponsored retirement plans, like 401(k) or 403(b) accounts, are one of the best ways to save for retirement. These accounts often come with employer contributions, which can boost your savings significantly. Ideally, you should aim to contribute at least enough to get the full match.
If your employer offers a pension plan, be sure to factor that into your income as well. Pension plans guarantee a fixed income for life, but they may have certain restrictions or benefits depending on your tenure with the company.
3. Personal Savings & Investments
Your personal savings and investment accounts will make up the bulk of your retirement fund. This includes money in your IRA, Roth IRA, stocks, bonds, and other investment vehicles.
When considering your investment accounts, take into account both the current balance and expected growth over time. A general rule of thumb is that your investments should grow at a rate that outpaces inflation—usually around 5-7% annually, though this can vary depending on your investment strategy.
4. Passive Income
If you’ve invested in real estate, dividend-paying stocks, or even have a small business, these can provide passive income streams during retirement. This is income that you earn without actively working, and it can supplement your savings significantly.
Calculate How Much You Need to Save
Now that you know how much you’ll need to live on and the various income sources you’ll have in retirement, it’s time to start crunching the numbers. Here’s a step-by-step process to calculate how much you need to save:
- Estimate Your Retirement Expenses: As mentioned earlier, you’ll need about 70-80% of your pre-retirement income. Don’t forget to include inflation, health care, and lifestyle changes.
- Subtract Your Expected Income Sources: Subtract the projected Social Security payments, pensions, and any other income streams you expect to receive.
- Calculate the Gap: The difference between your expenses and income sources is the gap you need to fill with personal savings.
- Multiply by Years in Retirement: Most people retire at age 65 and live into their early 90s, so if you retire at 65 and expect to live until 90, that’s 25 years of retirement. Multiply your annual gap by 25 to get an idea of how much you’ll need.
- Factor in Investment Growth: Your savings should grow over time, so factor in the expected annual return on your investments.
For example, let’s say you expect to spend $50,000 annually in retirement, but Social Security and pension plans will cover $30,000 of that. You’ll need $20,000 per year from your savings. Over 25 years, that comes to $500,000. Factor in an annual return of 5%, and you’ll need to save around $400,000.
How Much to Save Each Month
Once you know your total retirement savings target, you can figure out how much to save each month. If you have 20 or 30 years until retirement, you can divide your savings goal by the number of months you have to save. For instance, if your goal is $500,000 and you have 30 years to save, you’d need to save approximately $1,388 per month (ignoring interest for simplicity).
To make this even easier, consider using a retirement calculator to determine how much you should save each month based on your current savings, investment growth, and time horizon.
Don’t Forget About Healthcare Costs
One area that many people overlook when planning for retirement is healthcare. Healthcare expenses tend to increase with age, and Medicare doesn’t cover everything. You’ll still need to budget for things like Medigap, prescription drugs, and long-term care insurance.
According to Fidelity’s Retiree Health Care Cost Estimate, the average 65-year-old couple will need about $300,000 for healthcare costs in retirement. Make sure to account for these expenses when calculating your savings needs.
Adjusting Your Plan Over Time
As you move through life, your retirement plan may need adjustments. Life changes, such as a new job, marriage, children, or even health issues, can affect how much you need to save. Make sure to review your retirement plan regularly and make adjustments to stay on track.
Retirement may seem far away, but the sooner you start planning, the better off you’ll be. By calculating your retirement savings needs accurately, you’re setting yourself up for a future where you can enjoy peace of mind and financial security.
And remember—the earlier you start, the more time your savings have to grow.