How much do you need to save and invest for your retirement? Are you on track to retire? Even as inquiring minds want to know, this is one well-covered subject in personal finance.
I’ve often heard that in order to maintain the lifestyle we’re already accustomed to living, we’ll need to be making between 75% to 90% of our current pre-retirement income by the time we retire. That’s because we’re expected to spend less when we’re older, what with the mortgage paid off and college tuition presumably addressed and out of the way.
The rule of thumb — that we should target a post retirement income of at least 75% to maintain our standard of living — is typically applied to the average person. In actuality, depending on your life situation, spending levels and plans for the future, you may have to readjust your income expectations.
There are numerous ways to figure out how much of your income today needs to be funneled towards retirement. Here are a few:
3 Ways To Determine Your Savings Rate For Retirement
METHOD 1: Use a retirement savings table.
Following is a table from T.Rowe Price that helps you determine the annual savings rate required to yield your desired post-retirement income. The figures in this table are based on a few assumptions:
- Your target income is 75% of your salary today.
- You’re retiring at age 65.
- Your salary increases 3% annually to keep up with inflation.
- You earn 8% on your investments in a tax deferred account before retirement.
- The chart following shows the percentage of salary you should be investing today in order to replace 50% of your salary through investments by the time you retire.
- The other 25% of your post-retirement income is expected to come from other income sources such as Social Security and employer pension plans.
To figure out how to use this chart, proceed with the following steps:
#1 Determine how much money you’ve already saved for retirement, such as your 401K account balance as well as any IRAs you own.
#2 Compare this amount with your yearly salary. So if you’re making $100,000 and you’ve already saved $50,000 for retirement, you should check the 1/2x Annual Salary column in the chart below.
#3 Scan down the Age column to find the row that shows the number that’s closest to your age.
#4 Scan across the row to find the salary percentage you need to be saving in combination with your employer contributions.
| Age | No Savings | 1/2x Annual Salary | 1x Annual Salary | 1 1/2x Annual Salary | 2x Annual Salary | 2 1/2x Annual Salary | 3x Annual Salary |
|---|---|---|---|---|---|---|---|
| 25 | 10% | 8% | 5% | 3% | – | – | – |
| 30 | 14% | 11% | 8% | 5% | 2% | – | – |
| 35 | 18% | 15% | 12% | 9% | 6% | 3% | – |
| 40 | 25% | 22% | 19% | 15% | 12% | 9% | 5% |
| 45 | 37% | 33% | 29% | 25% | 21% | 18% | 14% |
| 50 | 56% | 51% | 47% | 42% | 38% | 33% | 29% |
| 55 | 95% | 89% | 83% | 77% | 71% | 65% | 59% |
The results are therefore based on your current age, how much you’ve saved so far and the fact that your expected retirement age is 65. Here’s an example that illustrates the use of this table:
If you are 30 years old and already have two times your salary in savings, then you’ll need to save and invest at least 2% of your salary annually from this point forward, till you reach the age of 65.
METHOD 2: Use retirement savings tools and calculators.
The table above really does assume many things, so I’d also encourage you to check out web calculators that exist for this same purpose. Be aware though, that the way these tools calculate their recommended savings results can be based on their own specific assumptions and a whole slew of other factors such as:
- Your current age.
- Intended retirement age.
- Life expectancy.
- Current earnings.
- Income sources during retirement.
- Amount of current retirement savings.
- Expected savings contributions.
- Cash outflows during retirement.
- Portfolio risk/return.
- Inflation.
Here’s one such retirement savings calculator. And another.
METHOD 3: Use a simple retirement savings formula.
If all this is just too much fuss, how about a “quick and dirty” formula instead?
Steps to follow:
#1 Determine your target retirement income.
#2 Decide on a “safe” withdrawal rate — the percentage of your retirement savings you plan to withdraw every year. Varying guidelines have suggested either a 4% to 6% annual withdrawal rate to best preserve your nest egg.
#3 Come up with the required savings amount to support your retirement lifestyle by using this formula:
divide your target post-retirement annual income by the withdrawal rate.
Example:
Suppose your target retirement income is 80% of your current job income. If you’re making $100,000 a year today, then 80% of that amount is $80,000, for your desired retirement income. Apply the formula: $80,000 / .06 and you get $1,333,333 as the amount you’ll need to have socked away by the time you have to draw from your savings.
There’s no shortage of tools that exist to give us a basic idea for how to proceed and plan, but the reality is that we’ll need to readjust and customize our savings program, playing by ear as we go through our lives.
In my case, I’ve made my savings process pretty simple. I try to maximize retirement contributions as much as possible, be it with 401Ks and IRAs. If you have a dual income household, maximizing contributions to a couple of personal IRAs as well as fully funding 401K contributions through your employers’ programs can really amount to quite a lot. These days, this is something we’re missing out on because of our limited work income and our new self-employment status. We’ve since scaled back our retirement savings contributions and are only funding IRAs that we are qualified to contribute to. But hopefully, things will change in the next few years as our businesses grow, so we can implement a more aggressive savings schedule!
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{ 21 comments… read them below or add one }
Fantastic article. FIRE Calc (http://firecalc.com/) is also a great tool to see how our nest egg would fare (with past data from the stock market).
Cheers,
FIRE Finance
I just pull a number out of my butt and hope for the best! 🙂
Jim,
Nope, don’t believe you. After all you’re the retirement account/plan expert around here… I’m 10,000% certain your methods are more sophisticated than you describe! 😉
I use a mix of method 2 and 3. “Determine your target retirement income”! is something I struggle with a lot!
You didn’t mention the notion of making extra income. My top choice for saving money is to make more instead. It may not be the easy road, but is television really that entertaining? What about figuring out new income ideas instead.
Scott,
I must argue your point that “television is not that entertaining.” For this gal, it is! I’m a terrible couch potato (though it’s a good thing I don’t really look like one…. 😉 ) and am a huge sucker for certain shows.
Vote David Cook! (oh in case you don’t know, he’s an American Idol contestant and promising rock musician).
Though, yeah, I must agree that trying to think of ways to make more $$ could be mildly entertaining. 🙂 I’ve got a friend who lives and breathes this sort of thing and after a while, it can get real boring though, when I’m subjected to the one dimensionality and obsessiveness of some entrepreneurs I know.
On the idea of earning more money, I ran across an interesting and radical proposal the economy and welfare/social security/medicare. Imagine this:
1) The economy has fixed pool of money growing at X% annually.
2) If you are growing your income faster than economy, that implies somebody else has their income not keeping up with the economy.
Hence, by outperforming others on the income arena, you are creating a larger and/or needier pool of future government benefits recipients that will increase your tax burden. Now people on welfare don’t exactly live grand lifestyles so it still is better to earn more money and pay taxes on it than it is to subsist on welfare. But it does imply that spending $1 less versus earning $1 more produces a larger net dollar benefit beyond today’s current tax structure would take away.
Whether this idea can be quantified and tested, I don’t know.
About three years ago, my in-laws started adjusting their expenses to what their retirement income was likely to be. They saved the leftovers. Now, with just a couple of years to go, they’ve got a cushion, and they know that it is possible to live on their retirement income.
When you calculate how much you need to retire, you also have to consider which kind of life you want at retirement.
Most people have a lot of projects on their mind (renovate the house, going on a around the world trip, starting a business). These projects might affect your cost of living at retirement and you may need 100% of your income as well.
Another thing that is crucial is to make sure that you don’t underestimate the power of inflation in your calculation. A small 2% over 30 years makes all the difference when it comes down to calculate your future income and needs.
Great article. I was going to do a post on my 401K experience and selection process on my blog – http://www.savingtoinvest.com – and wish I had this article earlier. I will still write about my experience but link back here for the useful information. The only thing I will add is you need to make estimates for inflation, expected post retirement tax rates and fees of the funds you select.
Cheers,
Andy – a subscriber.
That’s awesome. I’m 25, and already have 1x my salary in investments and am saving more than 5% monthly on my own, not including employer stuff!
you actually need more than your current income when you retire (not less) plus add inflation. this is because: you need to take health care into consideration (this is huge), also things you always wanted to do or places you always wanted to go after you retire. so your expenses is likely to go up.
Great post! When planning retirement, you had better get a couple of things ‘right’:
1. Your retirement income – planning on a +/- % of your current (or expected) retirement salary doesn’t work very well, if your current life isn’t your ideal life.
2. The Safe Withdrawal Rate – “4% to 6%” is a 33% range (from the max.) … what would you do if somebody ‘cut’ your expected salary by that amount!
“The economy has fixed pool of money growing at X% annually.”
You’ll have to decide between fixed and growing.
My favorite illustration is a guy with a bunch of bananas heading into the rainforest to sell them to villages along the trail. At some point he decides to increase his income and take along pieces of cloth as well. Now the villages get to eat and wear cloths too.
Increasing the number of people you help in this world is not such a bad way of life. TV is bad.
Very thoughtful post. Rarely do I see three methodologies offered for retirement planning. This is good because there is no “right” answer
Great in depth article, never thought about retirement. I know that when I retire, I want a big party!
Some good information to get people thinking there. Man, these markets will take a few years to recover…bummer
Thanks
I think you need 100% of your current salary – plus if you still have a bit of time to go before retirement you want a bit more as well! I know when I retire I want to enjoy life and travel rather than sitting at home waiting for death.
Also you would probably want to leave some for your family as well – so you will probably need to have 100% of your current income plus a lump sum for your family.
Here’s my financial question:
How much should a retiree have in an emergency fund? Most advice is 3, 6, or 8 mo. of income to cover job loss. However, as a retiree, I am not going to lose my job. My emergency fund covers my insurance deductibles, relocation expenses should I need to sell my home and move to smaller quarters, and a major health crisis to pay for what medicare and my secondary insurance won’t cover. My monthly retirement income comes from Texas Teacher Retirement and Spousal Social Security.
I haven’t thought much about my old age and retirement. I am thinking I will have to start my saving plans now for my happy retirement and it would be for the better if I start sooner. So far I have not bothered much with my retirement but now I should start with my personal investments and insurance policies and IRAs and then add other options.
@Ellyce,
I believe the answer depends on your spending pace as well as your comfort level. In my case, my emergency fund is pretty large — equivalent to a year’s worth of spending (annual budget). I’m just a more conservative creature. And recently, with the way things are going in our economy, I feel that cash is becoming a more enticing option. Quite a far departure from how I used to feel!