How Much Retirement Savings Do You Need?

Retirement planning is not as daunting as you might think. The first step is to figure out how much savings you will need to maintain a comfortable lifestyle during your golden years.

An essential element of retirement planning is to understand how much money you will need. The easiest way to estimate your projected living expenses is to use the 80% rule. This rule says you will need about 80% of your pre-retirement income to cover your living expenses during retirement. Many financial advisors agree that this is a safe rule of thumb when retirement planning.

Calculating How Much Savings You Need

There are many complex calculations that can help you determine how much money you need to save every month to ensure a relaxed and happy retirement. The simple steps listed below will help you get an approximate estimate of how much savings you will want to attempt to create for your retirement. An example is included. You may want to have pencil and paper or a calculator handy because you are going to have to do several calculations to complete this process. As you follow along, substitute your information to see how this five-step process works for you.

1. Determine your required annual retirement income. This is how much money you will need on an annual basis to pay for your living expenses. In order to do this, you'll have to guess what you think you will be making the year before you retire. You'll want to factor in salary increases between now and then. If you're still pretty young, or in the early stages of your career, it might be hard to predict what your future income will be, but give it your best shot. Remember, it's better to estimate conservatively at this point. After you estimate this future income, multiply that by 80%.

Example - Assume your current salary is $26,000 annually and you are 40 years old. You plan to retire at age 67 (27 years from now). You expect to receive a 4% salary increase each year between now and retirement.

In this example you would multiply $26,000 by 0.04 and add the product to $26,000 to get your next year's salary. Then you would repeat this step 27 times to estimate your income at the end of 27 years. It seems like a lot of math, but it's worth it and it won't take you that long to complete this step after you get started.

If your starting salary of $26,000 increases by 4% every year, you will be making approximately $72,000 in 27 years. Next, take your projected income of $72,000 and multiply that by 0.80 to get an estimate of how much annual retirement income you need. In this case the percentage would equal $57,600, meaning that you should have at least that much every year to cover your living expenses.

2. Obtain an estimate of your annual social security benefits. Social security benefits are an important element of your retirement income. You pay social security taxes throughout your working years, and will become eligible for a monthly benefit upon your retirement. You can contact the U.S. Social Security Administration (SSA) to obtain your estimate. Also, try their online Retirement Planner, which has a selection of benefits calculators. Visit the CareOne Credit Knowledge Center for otherarticles related to social security benefits.

3. Obtain an annual estimate of your pension benefit. Pension benefits, if applicable, are another important part of your retirement planning. If you are eligible, make sure you know approximately how much you can count on from your pension. Contact the benefits administrator of your employer and request an annual estimate.

4. Calculate your annual shortfall. You have estimated approximately how much money you need for retirement, and how much you will receive from social security and your pension plan benefits. You need to calculate how much of a retirement investment is necessary in order to have an income that meets your needs. Subtract the sum of your (annual) social security and pension estimates from the projected retirement income needed, which you calculated in Step 1.

In our example, your annual retirement income need is projected at $57,600, and your annual social security benefit is estimated at $34,068. Let's assume you are not eligible for a pension benefit. Subtract $34,068 from $57,600 and your annual shortfall is $23,532.

5. Determine the total amount of retirement savings you need. Multiply the annual shortfall you calculated in Step 4 above by the estimated number of years you expect to live in retirement. That figure is how much is needed for a comfortable retirement.

Assume you will live to the age of 90. Since you are retiring at age 67, this means you have a retirement span of 23 years. If we multiply the annual shortfall of $23,532 by 23 years, you'll need $541,236 (over and above your social security and pension benefits) to see you through retirement!

If you already have an IRA, 401(k), or other retirement plan, go ahead and subtract the balance of each of these accounts from the amount you calculated in Step 5 and you can reduce your retirement goal even further!

Keep in mind that this is a simplified version of a much more complex process which a financial professional may be able to pinpoint more precisely for you. This formula doesn't allow for several important factors, including the rate of return you might get on your investments, both before and after you retire. However, it's a great benchmark to determine how far away you are from comfortable living in retirement. For more information on retirement planning for your age group, read the related articles in our Knowledge Center Library.

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