How much should I have saved for retirement?

Factors that affect your retirement savings

Whether you're approaching retirement age or have just started saving, you might be wondering how much you should have saved by the time you retire.

There isn’t a magic number that works for everyone. But understanding what’s behind your retirement number, which varies based on things like your individual lifestyle choices, timeline, investment strategies and personal goals, can help you prepare for and enjoy your next chapter without financial stress.

Why it’s important to save for retirement

If you plan to stop working once you hit retirement age, you'll need sufficient assets to help you maintain your standard of living. Think of your retirement savings like acorns squirrels tuck away ahead of winter.

Because you'll likely be relying on savings later in life, the earlier you start to save, the better off you'll generally be. By saving for retirement early, your money will have more years to potentially grow, enhancing your sense of financial security and reducing the stress of having to save more later in life. Some may advise you to save everything possible for retirement, but over-saving may mean you can't enjoy other things or experiences earlier in life. Finding the right balance is key to spending comfortably today and tomorrow.

Two phases to your retirement plan

When planning for retirement, imagine two distinct phases: the accumulation phase and the spend-down phase.

The accumulation phase is when you're actively saving for retirement, while the spend-down phase is when you're using the money you've saved in retirement. Understanding these two phases can help you develop a comprehensive retirement plan that incorporates your current financial situation and your future needs.

The accumulation phase

Several factors can shape your accumulation phase and how much you’ll end up saving by the time you reach retirement age. For example:

1. Your starting point: The earlier you begin to save for retirement, the better. If you’re starting with a nest egg, like an inheritance or a life insurance payout, you may be ahead of the game. But don’t worry if you’re starting from zero. You can still achieve adequate retirement savings on your own.
2. Your contribution levels: Regular, significant contribution to your retirement savings can increase your potential end balance. General retirement savings can refer to contributing to accounts such as 401ks, TSP, IRA, or 403b plans.
3. Your rate of return: The rate of return on your retirement contributions can significantly impact your financial situation, especially over a long timeline. Higher-risk portfolios may offer better long-term growth, but you'll have to balance the risk with your comfort level, which includes both your emotional reaction to the markets' ups and downs and your financial capacity to withstand it. Many people have good savings habits, but are not investing appropriately for their goals, such as retirement. It’s critical to understand the difference between saving in something like a money market or CD and investing.
4. Your retirement needs: Are you saving just for yourself or for you and a spouse? Dependents? Do you want to leave a legacy for a family member? The more people you’re planning for, the more money you’ll generally need.

The spend-down phase

Once you reach retirement age (usually around age 65 for most), how much you will need to live on through retirement will depend on factors like:

1. Your starting amount at retirement: How much did you save before retirement? This will be part of your income in retirement.
2. Legacy desires: If you want to leave a legacy or inheritance for someone else or use your retirement savings to help provide for a spouse, it can affect how much you’ll have for your retirement lifestyle.
   
3. Your income needs: How much will you regularly need to withdraw‍ ‍ from your retirement investments? It’s crucial to balance your lifestyle costs and needs with the money you’ve saved, plus any other income sources like Social Security.
   
4. Longevity: Your medical needs and overall health can significantly impact your retirement spending. While longevity can be a blessing, it helps if you have the savings to support yourself, and possibly dependents, for the rest of your life.

The transition from saving to spending is often one of the most overlooked parts of retirement planning. For decades, you've likely been focused on building your retirement nest egg. Once retirement arrives, however, success depends on a different skill: using those savings in a way that supports your lifestyle while lasting throughout your retirement years.

Because of this shift, many people find it helpful to ease into the spend-down phase before they fully retire. Testing your retirement budget and spending patterns while you're still working can help you adapt to the change, refine your plan, and feel more comfortable relying on your savings when your paycheck eventually stops.

Predicting your lifetime needs

Your retirement spending level and how long you’ll live are the primary drivers of how much you’ll need to save for retirement. Therefore, given their importance in the retirement savings calculation, let’s take a closer look at these factors.

How much will you spend in retirement?

According to the U.S. Bureau of Labor Statistics, housing, food, transportation, and health care account for the majority of the budget for most people 55 and older. That doesn’t leave much money for everything else.

Will your spending increase, decrease, or stay relatively constant as you age? Several studies indicate that when accounting for inflation, most people spend less over time as they grow older than 65, whether single or married. Expenses also go down due to a "widowing" effect when spouses or partners die. In general, spending tends to decline in retirement regardless of savings because most people slow down as they get older and may be unable to do expensive things like travel.

Many financial professionals refer to the three stages of retirement as:

• The “go-go” years, usually ages 60 to 70, when retirees are most active.
• The "slow-go" years, typically when people hit 80 and start slowing down.
• The "no-go" years, ages 90 and above, when extra expenses dwindle the most.

How long will you live?

Longevity can be hard to predict. Who knows what medical needs you'll have in 30 or 40 years? However, to a degree, we can make some reasonable assumptions about our future health based on our family histories and individual situations.

How to estimate your retirement number

A long saving and investing timeline can make it easier to put money toward retirement goals. It can also make planning a bit tricky. For example, it might be hard to imagine what retirement will look like for you, especially it is still decades away. Here are a few common methods for estimating your retirement number whether retirement is near or far.

If retirement is far off

• Guestimate. There's no math behind this, it's just what people think they’ll need. This number may be higher or lower depending on the age group answering the question.
• Take a multiple of your most recent earnings. This rough calculation method assumes you should replace 70% to 85% of your final salary. Multiply your estimated or known final gross salary by 10 to 12 to find your retirement number.
  If your final salary is $80,000, you would need about $800,000 to $960,000 to get by in retirement.
• Use the 4% withdrawal rule. The 4% rule was devised in 1994 by financial planner William Bengen and has been reviewed in numerous subsequent studies. Bengen has adjusted the exact percentage a few times since 1994, most recently adjusting the withdrawal rate to 4.7%, but it is still commonly referred to as the 4% rule. This method provides a starting annual withdrawal rate you could take from your retirement accounts with a potentially low risk of running out of money during a 30-year time horizon, assuming an allocation of 50% stocks and 50% bonds. Instead of using your salary as a starting point, this method looks at your withdrawals from your investment portfolio. For example, assume your essential retirement lifestyle expenses are $60,000 annually, and your Social Security and small pension equal $40,000. In this case, your expense gap is $20,000 per year, and the amount you'll need to fund from your retirement savings. Divide the gap of $20,000 by 0.04, and the result is $500,000, which is the amount you would need at the start of retirement, according to the 4% withdrawal rate rule of thumb. The assumption is that you could take $20,000 from your $500,000 portfolio and then increase the starting withdrawal by inflation each subsequent year with a high probability of not running out of money. Of course, this assumption is just that, an assumption, and not a guarantee.

As you get closer to retirement

The 10–15-year period before retirement is key for adjusting your financial strategy to protect accumulated savings, plan for healthcare, and make informed decisions about income sources, given the shift from growth to preservation.

By now, you should probably have more clarity regarding your expenses and longevity to help you arrive at a more precise number. You might be able to estimate a more precise retirement budget at this time, factoring in how some major expenses may change once retired, such as housing costs, medical expenses, transportation, no longer saving for retirement and no longer paying payroll taxes.

You can still use some of the previously discussed methods to validate your retirement number. Here are a few additional methods.

• Immediate annuity method. People buy single premium immediate annuities, or SPIAs, to generate a retirement income stream they can't outlive. However, you can also use the SPIA calculation to estimate your retirement savings. Using the same previous example where our retiree estimates they'll need about $20,000 per year to get by (the gap for expenses not already covered by Social Security or pensions) you can have an insurance company estimate of how much you would need to start with to provide that income for the rest of your life, or joint lives. For example, take a 65-year-old couple who thinks they’ll need about $20,000 per year as long as one spouse is still alive. To receive $20,000 per year, or $1,667 per month, the couple would need a lump sum of about $300,000. You may notice that this number is significantly lower than some of the other estimates, which is due to the nature of annuities and how they work. The insurance company is taking on the risk of you not running out of money, and in return, you forfeit the $300,000 principal.
• Your personalized retirement plan. At this stage in life, you want to rely on something other than rules of thumb and guesswork regarding retirement. That's when a professional can be helpful. Your financial institution may have a retirement services team with the proper tools necessary to help you verify your retirement income needs and get closer validation of your retirement number. They can help you create a retirement plan based on more precise assumptions regarding longevity, spending levels across retirement, rate of return on your investments and inflation rate. It may also include a cushion for unexpected health-related or non-standard expenses.

Conclusion

To effectively determine your retirement needs, focus on understanding your projected income and expenses, and begin planning now. Consulting with professionals, particularly as you approach retirement, can further refine your strategy and ensure you're well-prepared for your future.