In retirement planning, figuring out what you want to save is half the fight.
Before starting your retirement planning, you must determine how much money you must save.
But calculating out how much you’ll need for retirement isn’t an exact science. The following general guidelines may be known to you: “you should be able to replace 80% of your pre-retirement income” or “you should have 10 times your final year’s salary in investments.” However, there are a number of problems with these values, not the least of which is that if retirement is still decades away, it is hard to know how much you will make in your 60s.
Relying on a one-sentence rule that says everyone’s departure is meaningful will never work. So it’s good to have a framework for determining how much you’ll need in retirement.
How to accurately calculate how much money you need for retirement in 3 easy steps.
Step 1: Estimate your budget
This is the most difficult part of determining how much money you’ll need in retirement.
The farther away you are, the more difficult it is to get a pension. However, reasonable estimates can be used to determine standard ranges, and estimates are sufficient for now. As you get closer to retirement, you can adjust and narrow down your estimates to more accurately reach your goals.
You should revisit your retirement budget estimates every few years or when there are major changes in your life to ensure they still make sense.
First, you need to figure out how much you are currently spending. If you’re not sure, check your credit card and bank statements from the past few months to get a rough idea of how much you’re currently spending annually.
From there, you can adjust your budget based on what you expect will change in retirement. If you have paid off your mortgage by then, it won’t cost you much. If you don’t have a job to commute to, you’ll probably save money on gas and car insurance.
The budget has also seen some additions. Early in retirement, a lot of people take more trips. Additionally, they will require significantly higher medical care costs as they age.
Once you know the approximate amount of your retirement savings, you can move on to the next step. However, as mentioned above, as your retirement vision becomes clearer, be sure to come back and review your budget estimates periodically.
Step 2: Determine your safe withdrawal rate
A safe withdrawal rate is the amount you can withdraw from your retirement savings each year with a reasonable expectation that you won’t run out of money. This is important in determining how much you need to save for retirement.
The 4% rule, which was created by financial counselor Bill Bengen approximately 30 years ago, is frequently used by retirement planners. He discovered that, after accounting for inflation, a retiree who has an equal mix of medium-term Treasury bonds and stocks in their portfolio can withdraw 4% of the initial value each year. There’s a very good chance you won’t run out of money in 30 years if you do this. In actuality, you’ll frequently obtain more than you first did.
A great place to start when planning for retirement is using the 4% rule. That safe withdrawal rate, however, might need to be modified depending on a number of factors.
First, you can choose a greater withdrawal rate if your planned retirement is shorter. That being said, the largest risk period is immediately following retirement, so you might only be able to increase it by a quarter or half a percentage point. Similarly, you must reduce your safe withdrawal rate if you want to retire for an extended period of time. Once more, you don’t need to reduce it significantly.
If you’re prepared to lower your withdrawal in the event of an unfavorable run of returns in your early retirement years, you could be able to use a greater withdrawal rate. According to current studies, you may be able to start with a withdrawal rate of 5% or higher if you leave room for changes.
In general, you’ll probably settle for a payout percentage of 3.2% to 5.0%. If you’re a conservative person, you’re wrong on the low end.
Step 3: Calculate your number
The next action is to devise a strategy to meet that savings target prior to retirement.
This framework provides you with the best estimate of just how much you’ll need in retirement, however you’ll need to review your figures from time to time as things change and the bigger picture of your retirement becomes clear.
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