While a hard and maybe scary question, it is critical for those approaching retirement to get a really good answer: How much should I save for retirement?
With healthcare costs expected to be over $200,000 for the average 65-year-old couple retiring this year throughout their retirement, it’s important that consumers come up with a concrete plan for how to save and where to invest.
While there is no one-size-fits-all approach when it comes to financial retirement planning, industry experts reveal there are tried and true practices to help you determine how much to save for retirement
First, Know What You Want
When figuring out how much you need for retirement, you will need first to know how you want to live your life in retirement. More specifically, how much will you be spending? Planning to spend about what you currently spend is usually a good rule of thumb. (However, watch out for unexpected retirement expenses. (See the top 5 overlooked retirement costs here.)
Ask Some Important Questions
There are a few important questions you should ask yourself and those who are assisting you in retirement or managing your money, says Michael Niemczyk president of Grayslake, Ill.-based MLN Retirement Planning, Inc.
Ask yourself:
- How do I ensure I don’t run out of money before I run out of life in retirement?
- How is my portfolio, income and lifestyle protected from a market crash or correction if I still need a dependable monthly income?
- If my spouse dies tomorrow, how will that affect my monthly income requirements or desired amount?
“When you retire from your job, a reliable income stream from a pension or a lump sum portfolio or both is crucial,” Niemczyk says. “Too many retirement plans made before and after retirement are left to chance and hope.”
Income Paths Matter
While knowing what you expect in retirement is important, so too is understanding the impact income distribution will have on later retirement funds.
In particular, for individuals in the upper end of the income distribution at 65, for whom income growth is greater than expected, relatively low savings at the beginning of their careers will not be enough to replace the high income earned as they neared retirement, finds a recent study by Dimensional Fund Advisors LP.
“One way to improve the chances of a successful retirement—particularly for individuals who experience higher income growth—is to have saving rates change as income changes,” the Dimensional study advises. “A natural way to increase the success rate is to increase the rate of saving as income increases.”
Run The Numbers
A typical household should get a third of its retirement income from a savings plan, with the low income needing one quarter and the high income one half, finds a 2014 study by Center for Retirement Research at Boston College.
Social Security and other benefits will also impact the portion of retirement income that needs to come from retirement savings.
Using the National Retirement Risk Index framework, which is used to address how much working-age households need to save for retirement, the Boston College study determined that a typical household needs to save about 15% of earnings—less for low income households and more for high income households.
For those with a savings shortfall, the necessary savings hike is much more feasible for younger households than for older households, research shows.
Account for Inflation
One of the biggest surprises in retirement planning, and what’s rarely discussed or figured into the plan, is inflation, Niemczyk says, noting that soon-to-be retirees should plan for inflation above the government’s current inflation rate of 2%.
“When healthcare, prescriptions, energy, fuel and food are added in, as they should be, the true inflation rate is between 5% and 8%,” Niemczyk says.
Using the Rule of 72 is another tool that can help you arrive at the dollar amount needed during retirement, he says.
The rule number is divided by the inflation percentage per period to obtain the approximate number of years required for doubling.
“So, if you use a 3% inflation rate divide 72 by 3,” he says. “Therefore, if you are currently living on $50,000 now you will need $100,000 in 24 years to live the same lifestyle.”
Regardless of what amount you determine best fits your financial retirement needs, starting early and consulting a financial advisor are key to making the most of your later years, financial experts agree.
