It’s never too early to start putting together a retirement plan, but you won’t get very far if you’re not asking the right questions. The most basic questions are:
- How much money do I need to retire?
- How do I figure out how much money I’ll need?
Those questions may almost seem a little too basic to you, but the truth is this: Most people either haven’t thought about or are ignoring them altogether.
How Much is Everyone Else Saving for Retirement?
Exactly how well-prepared are people for the expenses associated with retirement? Let’s take a look at the numbers.
Baby Boomers: Completely Under-Prepared for the Cost of Retirement
You might expect the baby boomers (born between 1946 and 1964) to be the most financially responsible and largely prepared for their retirement needs. But, that’s not necessarily the case.
The average retirement currently lasts 18 years, so at a cost of just under $49k per year, baby boomers are falling well shy of the $880,000 they should have saved up.
But it’s not just a problem for older generations.
Millennials: “Outlook Not So Good”
For a variety of reasons—whether a comparatively late start on earning or burdensome student loan debt, millennials (generally understood as anyone born between 1979 and 2000) struggle to catch up with previous generations in their retirement savings and preparation. Distinctive spending habits are also a factor, but the COVID-19 quarantine has presented unique challenges to millennials.
Millennials are more likely than previous generations to dip into their retirement savings, and the uncertain market during the pandemic has given them all the reason they need.
Most people aren’t saving enough for their retirement, but why is your retirement savings so important anyway?
Why Do You Need to Save for Retirement?
There are several reasons why you should be saving money for your retirement.
Social Security won’t cover all of your expenses
Advisors estimate that you should have around 70% of your pre-retirement income to carry you during your retirement years. Depending on how much you earned and when you decide to retire, Social Security might only cover 40% of your pre-retirement income (for medium earners retiring at age 67) or as low as 27% (for high earners).
Of course, this assumes you are able to retire when you want, and don’t have to retire early due to unforeseen circumstances.
Investing and the compound effect
While you’re still earning before retirement, you could be investing your money in a tax-deferred account. With the right interest rate, your investment will more than cover whatever amount is due to the tax authorities while increasing the amount of your investment, before gaining interest again.
The smart play is to save for retirement now so your money can start earning for you all on its own. The longer you’re at it—and the more you invest—the better your chances of saving enough to meet your goals.
‘So How Much Money Do I Need to Retire?’
No doubt about it, you need to be saving for retirement, but how do you determine the right amount to invest? Here are some guides to help you think it through.
Common Retirement Saving Rule #1: Multiply annual spending by 25
One of the broadest rules of thumb people apply to saving for retirement begins by figuring out how much you spend each year and then saving 25 times that amount. If you can save whatever your annual spending is times 25, then you can live off 4% of that total amount every year.
Putting some numbers behind that, if you spend $40,000 per year now between all your expenses (rent/mortgage, groceries, bills, etc.), that means you’ll need to save $1 million for retirement.
Common Retirement Saving Rule #2: The 80% Rule
Another simple rule you can follow reframes the question from spending to income.
Expenses in retirement tend to drop, due to the fact you’re no longer paying for work-related expenses such as commuting, eating out, new clothes, etc.
This rule says you only need about 80% of your pre-retirement income to live off after you retire. Now this percentage can be adjusted up or down according to the kind of retirement you plan on, but the basic idea is the same.
If you fall into “typical” retiree ranges of spending with a combined household income of about $120k, you’ll need $96k, or $8k per month.
When Are You Planning to Retire?
One important piece of the retirement saving formula is when you plan on retiring. Here are some factors to consider:
- Currently, full retirement age is 66 (rising to 67 for people born in 1960 and later).
- The earliest you can get Social Security is age 62, but claiming early will result in a decreased payout amount in every check you receive for the rest of your life.
- Social Security benefits max out at age 70. Checks could be 24%-32% more than at full retirement age (up to 76% larger than what you’d get at 62).
Of course there are other factors, too. For instance, if you’re part of the FIRE crowd (Financial Independence, Retire Early), then you are going to want to save a lot more aggressively so you can move retirement up a couple decades.
What if You Haven’t Started Saving Yet?
As the old saying goes, the best time to start saving for retirement is yesterday. But that’s simply not the case for the majority of the population, from boomers to millennials and everywhere in between and beyond.
So what are you supposed to do if you didn’t start saving for retirement as soon as you got your first job?
Thankfully, there are ways you can catch up. The government even makes exceptions for late-comers with a category of savings called “catch-up contributions.” One of the first places we encourage people to look is at your workplace benefits to make sure you’re maximizing those wherever possible.
If you’re playing catch-up, the best thing you can do is get started today rather than waiting for the “right time.”
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