Saving for retirement is the granddaddy of all financial goals--but how much do you really need? Find out where retirement income comes from and easy ways to figure the amount of savings and income you'll need to enjoy a comfortable retirement.
Saving for retirement is what I consider the granddaddy of all financial goals because it typically requires a huge nest egg. But planning how much you really need to save in order to have enough to retire is more like an art than a science.
I think about retirement as a big party you’re planning when you don’t know exactly when or where it will be, how many people will show up, or how long it will last. There are many variables, which means there isn’t a one-size-fits-all answer for how much you should have.
Despite how confusing retirement planning may seem, I’ll make it simple by explaining where retirement income comes from and how much money you’ll need.
How Much Income You Need in Retirement
The whole point of saving for retirement is so you can continue enjoying a good lifestyle even after you stop working. Most people reach an age when they’re ready to slow down or they’re unable to work due to poor physical or mental health.
Having a secure retirement means you have enough in savings to preserve your pre-retirement income or standard of living. You’ll probably want to buy the same food, shop for clothes in similar stores, and enjoy the same hobbies. You might downsize to a less expensive home or have lower transportation expenses, but other costs, such as medical bills and travel, could go up.
A common target is to have 70% to 80% of your pre-retirement income after you stop working. For instance, if you earn an average of $100,000 in the years leading up to retirement, you might need a minimum of $70,000 to enjoy a similar lifestyle. However, the lower your income, the more difficult it may be to live on less in retirement.
My goal is to have no less than 90% of my income, and ideally 100%, in retirement. My expenses may drop in the future, but I’m not planning on reducing my standard of living by much.
If you have high aspirations for retirement, such as owning a second home or travelling extensively, there’s nothing wrong with planning for more than 100% of your pre-retirement income. Also, your future debt—such as a mortgage or student loans for a child’s college—should be taken into account.
Let’s cover typical sources for retirement income and how much you’ll need to make sure you don’t run out of money.
Your Social Security Retirement Benefits
In the United States, most workers are eligible for Social Security retirement benefits. Social Security is a group of benefits that give income to those who are retired, disabled, or survive a relative who was receiving benefits.
The Social Security program is funded from payroll taxes and the self-employment tax. If you’re an employee, you may see the deduction listed on your paycheck as OASDI, which stands for old-age, survivors, and disability insurance.
To qualify for Social Security retirement benefits you must generally work a minimum of 10 years. The calculation for how much you’ll receive is based on the average of your highest 35 years of earnings. If you worked fewer than 35 years, the missing years are factored in as $0 income. And if you worked more, only your highest-earning years are considered.
The program taxes earnings up to an annual threshold, which has increased over time. For 2018, Social Security tax for employees is 6.2% of earnings up to $128,400. Your employer also pays an additional 6.2% on your behalf.
If you’re self-employed you pay into the system on your own, but you have to pay the full amount, or 12.4%, up to the same amount of annual income. If your income exceeds the annual threshold, it’s no longer taxed until the following year.
The retirement benefit you receive varies widely depending on how old you are when you take it. The full retirement age has gradually increased over time because we’re living longer. If you were born between 1937 and 1959, your full retirement age is 66. But if you were born in 1960 or later, you must wait until age 67.
However, no matter when you were born, you can elect to take an early retirement starting at age 62. Problem is, you receive a permanently reduced rate, so it’s not always the right decision.