Episode 183: April 27, 2011
by Laura Adams
You know that you need to save for retirement, but exactly how much money do you really need? The answer to that question is as unique as your fingerprints. There are many factors that go into retirement planning, like how long you want to work and the lifestyle you want to live after you say goodbye to the working world. I’ll cover the major factors to consider and point you in the direction of some great online retirement calculators. It’s simple to enter your information and find out approximately how much you’ll need to finance your dream retirement.
How Much Money Do You Need for Retirement?
The financial actions you take (or don’t take) today directly affect the security you’ll have in the future. If you’re relatively young—perhaps in your twenties or thirties—retirement may seem too far off to worry about. If you haven’t started saving yet, one of the best ways to get motivated is to figure out the approximate lump sum amount that you’ll need for retirement. For most people it’s a shockingly large number that approaches $1 million or is even as high as several million dollars. But before you freak out, you might be surprised by how much you can accumulate when you start saving for retirement sooner rather than later! Use the My First Million Calculator at the bottom of this page to see how quickly you could rack up a cool million bucks for retirement.
Investing early and consistently is an extremely powerful yet simple way to grow your retirement portfolio.
How Compounding Interest Works
The more time you have until retirement, the more you’ll benefit from compounding interest. Here’s an example: Let’s say John invests $100 a month beginning at age 25 in his 401(k) retirement plan at work. His co-worker, Polly, also invests $100 but she starts at age 35. Assuming they both get an 8% annual return and both retire at age 67, John will have over $412,000. But poor Polly will have less than $178,000. Investing early and consistently is an extremely powerful yet simple way to grow your retirement portfolio.
How to Figure Out How Much Money You Need For Retirement
Here are eight variables that influence how much you’ll need for retirement—they’re also the types of data that you’ll be prompted to enter into a retirement calculator:
The age you want to retire. How long you want to work is an important variable because the earlier you retire, the more you’ll need to save. Most people use the date they’ll start receiving Social Security benefits (somewhere in their mid-sixties) as their default retirement date. But if you accumulate a large nest egg, it’s possible to retire much earlier.
How much you already have saved. As I mentioned, the earlier you start saving for retirement, the more likely you are to reach your goal. The more money you already have working for you, the better.
How quickly your money will grow before retirement. The average annual rate of return you receive on your investments before retirement is super important. For example, if you invest $100 a month for 40 years at a 5% annual return, you’ll have over $152,000. But if you get a 10% return instead, you’ll have over $632,000! There’s no way to predict the growth of your retirement portfolio, but most retirement calculators default to 7% or 8% because that’s consistent with historical stock market returns.
How quickly your money will grow during retirement. The average annual rate of return on your investments is likely to be lower after you retire. That’s because you’ll want to keep your nest egg in low-risk investments to keep it safe. Retirement calculators may suggest a rate in the range of 4% to 6%.
How much Social Security and other income you’ll receive. Social Security and any other additional income that you expect to receive, such as a pension, must be included in your retirement planning. If you’re an average worker, Social Security benefits may replace approximately 30% of your pre-retirement income. However, benefits may be reduced in the future and the age you can collect them may also go up. Go to ssa.gov to find projections for your annual Social Security retirement benefits.
The inflation rate. Inflation is a rise in prices over time that makes money less valuable. Let’s say you want to have a million dollars when you retire in 30 years. Assuming a 3% rate of inflation (which is what it’s generally been in the U.S.), you’d actually need to have over $2.4 million dollars saved up to compensate for the gradual rise in prices of goods and services over the next 30 years!
How long you’ll live. Your life expectancy is certainly unknown, but unless you have a reason to believe that you won’t be healthy, it’s likely that you’ll live well into your 90s. So even if you retire at age 75, you may need enough to live on for another 20 years.
How much you’ll withdraw annually during retirement. How much money you’ll take out of your nest egg each year is very important. Most retirement calculators ask you to estimate this amount as a percentage of your pre-retirement income. Many people believe they can live on less during retirement—perhaps 80%. But if you plan on taking lavish trips, living in an expensive area, or believe you may need costly medical care, you may need much more to finance your retirement.
How to Use Online Retirement Calculators
At the end of the post you’ll find links to several good retirement calculators that are all a little different. My recommendation is that you try out a few and play with the results. See what you’d need to save each month to retire at 60 versus at 70, for instance. Vary the expected rate of return to see how that affects your results. Find out an approximate total nest egg that you’re shooting for—is it $500,000, $1 million, or $5 million?
If you’re young and don’t feel comfortable about using a retirement calculator because you have to estimate so many unknown future variables, here’s a really simple solution: Save a minimum of 15% of your gross or pretax income every month and invest it as aggressively as your risk-tolerance allows. If you do that, you’ll be off to a great start.
And no matter your age, one of the best quick and dirty tips that I can give you is to take advantage of any amount of employer matching that may be offered in a workplace retirement plan. Using tax-advantaged accounts (such as a 401(k), 403(b), or an IRA) to invest will help reduce your taxes so you can put away even more for your future financial security.
The podcast edition of this tip was sponsored by Resume Rabbit. Resume Rabbit posts your resume to 85 different job sites and gives you exposure to 1.5 million different employers and recruiters—that saves you hours of work! Get a 10% discount when you go to podcast.resumerabbit.com/qdt.
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