The hardest part of retirement planning is projecting how much money you’re going to need to save. There are so many variables and even if you think you have a handle on what you’ll be doing when you finally retire, life loves to throw curve balls. So how can you go about calculating exactly how much you need to save when retirement is not yet a reality?
The best place to start is with the basics: What’s your estimated budget? That is, how much do you expect to spend? Knowing your expenses is the keystone to budgeting success. Consider all of your non-discretionary spending, including housing, food, and even your taxes. If you’re having trouble estimating, you can use a worksheet to help you track your month-to-month expenses to give you a better idea of what you’re spending now.
Once you’ve considered all of your necessities, you should also estimate your discretionary spending. This can include expenses like travel and entertainment, gifts that you give to family members, or money that you spend on hobbies.
Get Your Buckets in a Row
Now that you know what you’re spending, you need to know what you’re making. You’ll need to consider your whole portfolio of assets, which can include multiple income streams. For example, if you have a 401K and you plan to collect Social Security, you’ll need to include both of those income streams. Other sources of income include real estate investments, business investments, and salary if you plan to continue working part-time during your retirement. Add all of this up to find your total monthly income, and deduct taxes.
Now, subtract your budget from your after-tax monthly income. That will give you a good idea of where you stand currently—and how much more saving you might need to do.
Consider the 4% Rule
The 4% rule is a good rule of thumb for retirement savings. In theory, you can expect to withdraw 4% of your portfolio per year in each year of your retirement without needing to worry about running out of money. Of course, the 4% rule isn’t hard and fast, since it doesn’t account for things like inflation or shocks to the market. Nonetheless, it makes a great starting point for determining whether you need to save more to reach your retirement goals.
For example, if your budgeting shows you need $40,000 per year, before taxes, to sustain the lifestyle you want to live, your portfolio will need to be worth about $1 million. Keep in mind that your total portfolio should be worth about $1 million. If you estimate that sustaining your lifestyle will cost about $80,000 (after taking into account Social Security and other income sources), you’re looking at a $2 million portfolio.
While most people will simply suggest they should save more to offset any shortfalls, you should also consider adjustments to spending habits, not just your saving patterns. Consider, for example, what expenses you really can’t live without and which things are just luxuries. You can also think about your lifestyle—maybe you don’t need a big house in retirement, or perhaps you’d like to live somewhere else, whether that’s across town or on the other side of the globe.
You can also adjust your expectations. Many people assume they won’t work a day after they retire, but plenty of people find that they need to. Some people even discover that they want to work after they retire, to stay busy and active. Keep your mind open to opportunities as they present themselves.
If you’re still seeing shortfalls after making adjustments, or if you’re just not comfortable making major lifestyle changes, you should adjust your savings rate. Meet with your financial advisor to talk about periodic investment programs, asset allocation, and other strategies to help you save toward your goals.