How much money do you need to comfortably retire? $1 million? $2 million? More? Financial planners often recommend replacing about 80% of your pre-retirement income to sustain the same lifestyle after you retire. That means if you earn $100,000 per year, you’d aim for at least $80,000 of income (in today’s dollars) in retirement.
However, there are several factors to consider, and not all of this income will need to come from your savings. With that in mind, here’s a guide to help.
When calculating how much money you will need to retire, there is an important strategy to keep in mind: It’s not necessarily about attaining a certain lump sum of savings, but rather, establishing a sufficient, continual income.
For example, the most common retirement goal among Americans is a $1 million nest egg. But this is faulty logic. The most important factor in determining how much you need to retire is whether you’ll have enough money to create the income you need to support your desired quality of life after you retire. Will a $1 million savings balance allow you to create enough income forever? Maybe, but maybe not.
So how much income do you need? You don’t need to replace 100% of your pre-retirement income because when you retire, you’re typically able to reduce or eliminate certain expenses such as:
- No longer having to save for retirement (obviously).
- Spending less on commuting, parking and other expenses related to going to work.
- Potentially having your mortgage paid off by the time you retire.
- You may not need life insurance if you no longer have dependents.
Let’s say you and your spouse currently have a combined annual income of $120,000. Based on the 80% principle, you can expect to need about $96,000 in annual income after you retire, which is $8,000 per month.
But retiring on 80% of your annual income isn’t ideal for everyone. You might want to adjust your goal up or down based on the type of retirement lifestyle you plan to have and if your expenses will be significantly different.
For example, if you plan to travel frequently, you may want to aim for 90% to 100% of your pre-retirement income. On the other hand, if you plan to pay off your mortgage before you retire or downsize your living situation, you may be able to live comfortably on less than 80%.
Taxes — Not all retirement plans are equal when it comes to income. Money you withdraw from a traditional IRA or 401(k) will be considered taxable income. On the other hand, any money you withdraw from a Roth IRA or Roth 401(k) is generally not taxable at all, which may change the calculation a bit.
Early Retirement — Many workers have to retire earlier than they planned. For example, about 3 million workers retired earlier than they anticipated for reasons related to the COVID-19 pandemic. Even in normal times, older workers often have to retire early because of layoffs, health problems or caregiving duties. Saving for a longer retirement than anticipated gives you a safety cushion.
Inflation — Inflation has gotten a lot of attention in 2022 as prices have increased at the fastest pace we’ve seen in 40 years. But even when costs rise at a typical rate, inflation hits senior households harder than working-age households. That’s because seniors spend a higher portion of their incomes on expenses such as health care and housing, which tend to increase faster than the overall inflation rate.
However, there is no perfect method of calculating your retirement savings target. Investment performance will vary over time, and it can be difficult to accurately project your actual income needs. It’s always best to consult a financial advisor who can not only tailor a retirement savings goal to your particular situation, but can also help set you on the right path with a savings and investment plan to help you reach your goals.
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