How to calculate your retirement savings target

August 24, 2021
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It’s never a bad idea to sit down and work out your retirement savings target, but the most important thing is simply to start. You can always adjust your investments later, but you can’t get back lost gains! That said, at some point, you’ll need to get realistic about your savings and start taking a look at how much money you’ll need and whether you’re on track to get it.

Simply putting some thought into it will actually put you well ahead of many other investors! Surveys like TD Ameritrade’s 2019 “Road to Retirement” and the 2020 Employee Benefits Research Institute “Retirement Confidence Survey” show that while most workers are fairly optimistic about retirement, one of the most important financial stages of life, not many of them have actually done any calculations to assess their actual position, and being under-prepared is generally more common than being on track. Luckily, a few ballpark assumptions and some light math can get you a pretty long way!

Find your target

Finding your retirement savings target

The whole goal of retirement savings is to provide regular income, so a good starting point is to ask yourself, “What yearly income should I plan for when I retire?” There are three main factors you should consider here: 

  1. What kind of lifestyle you predict you’ll want in retirement
  2. How much your investments will grow
  3. The inflation rate

The answers to 2 and 3 are fairly straightforward: many retirement planners use 7% as the average investment growth rate and 3% as the average inflation rate. Returns since 1926 have actually been closer to 10%, but inflation over the last 100 years has averaged about 3%, so your money’s real value only grows about 7% every year. Using that 7% figure will help ensure that you save enough to make up for the value your money will lose over time.

The hard part is predicting your retirement lifestyle and how much it will cost. You can really only make educated guesses about that, but here are a few strategies that may help you pin down a number.

Step 1: The 70-85% suggestion

A standard piece of advice is that you should aim to have about 70-85% of your current income when you retire. That’s because you’ll likely have fewer expenses, like loans, mortgages, childcare, etc. However, costs related to healthcare and travel may increase more or less than you expect, so it’s worth considering which expenses you expect to rise. 

The big question, though, is “70-85% of what, exactly?” If you’re 25, just starting your career, you’ll probably be making significantly less than you will in your 50s. Setting your savings target based on your starting salary may set you up for a fairly frugal retirement.

A decent solution here is simply to make a ballpark estimate. How much do you expect to be making when you retire? What percentage of that do you think will be sufficient for your lifestyle? If you’re early in your career, it’s okay to be quite general here, looking at the income/lifestyle you aspire to have in the next 20 years or so. If you’re further on, you can probably be more specific. The important thing is that you settle on a realistic number that you can use for the next stage. 

Step 2: Multiply by 25 and Withdraw 4%

While they’re often put together, “Multiply by 25” is about finding your target, while “Withdraw 4%” is about how much you can withdraw from your account in retirement without eating away at the principle.

Multiply by 25 (or 20, or 10, or 7…)

The concept is fairly simple. Decide how much you want per year in retirement, then multiply that by 25 to ensure that you’ll have enough saved to weather ups, downs, and market shifts for at least 25 years. If you keep your money invested while you withdraw, you can get even more than 25 years out of it and possibly end up with a sizeable nest egg.

For example, if you want to spend $50,000 (in today’s dollars) per year, you’ll need to save $1.25 million (also in today’s dollars). If you want to spend $60,000, you’ll need to save $1.5 million. It can seem like a lot, but if you manage it, you’ll be very nicely set up for a stable retirement.

25x your retirement spending is fairly ambitious, though, and should be viewed as an ideal target, not a minimum. Fidelity, for example, says that saving 7-10x of your household income is enough to set you up for a comfortable retirement. If you’re the planning type, you may want to calculate both a minimum target and an ideal target.

Withdraw 4% [Optional]

Whatever amount of money you have saved up, if you keep it well-invested and only withdraw 4% of it, adjusted upwards for inflation every year after the first, you can generally expect the returns to more or less outweigh the withdrawals. That means that if you start with $100,000 and withdraw $4,000, you’ll probably get that $4,000 back by the time you make the next withdrawal. 

This rule depends on assumptions about returns, inflation, and asset allocation, but the general principle is useful regardless of how accurate the 4% figure is. Withdrawing a small part of your portfolio each year and letting the rest continue to grow is a good way to ensure that you have a sustainable retirement safety net. 

Bending the rules

There are varying opinions on both of these rules, and neither one is a one-size-fits-all solution. Saving 25 times your retirement income may be impractical for you, and that’s fine—with Social Security and smart money management, you can still enjoy a long retirement on much less. Withdrawing 4% allows you to keep most of your money intact, but you may be able to safely withdraw more without running out of money too quickly. These are individual decisions that depend on the variables in your own life, so it’s probably best to think of these rules mostly as helpful targets or best-case scenarios rather than prerequisites for retirement.

Accounting for Inflation

Accounting for inflation when calculating retirement savings target

As depressing as it is, your money will be worthless in the future than it currently is. Something that cost a dollar in 1913 would cost $26.25 in 2020. Something that costs $1.00 now will probably cost around $1.80 or more 20 years from now. This means that if in 20 years, you want to spend $50,000 a year in today’s money, you’re going to have to save around $90,000 in tomorrow’s dollars in order to be able to buy the same amount of goods and services. 

Don’t panic, though! It’s already factored in. The 7% average returns figure accounts for inflation, so if a 7% growth rate puts you on track to meet your goal in today’s dollars, you’ll probably have enough in tomorrow’s dollars as well. Remember that the stock market’s actual returns are around 10% a year and inflation is about 3%, so using the 7% number means you’re underestimating the number of dollars you’ll have, but accurately estimating your spending power.

For example, $1,000 invested for 10 years at 7% will return $1,976. At 10% it returns $2,594. After 10 years of 3% inflation, $2,594 is equivalent to about $1,913, which almost completely makes up for the loss in value.  

So why should you adjust your targets for inflation? Basically, this helps you stay realistic about your savings. Getting close to your target in today’s dollars doesn’t mean you should stop saving—it means that you’re well on the way to where you’ll need to be in tomorrow’s dollars.

The table below shows the numbers you’ll have to multiply by to figure out what your inflation-adjusted target should be. 3% is average but using the 4% number may be a good idea given that recent inflation rates have tended to be higher. 

For example, if you want $50,000 a year, have a goal of $1.25 million, and are 20 years from retirement, you’ll need to multiply those numbers by 1.8 to account for 3% inflation or 2.19 for 4% inflation. That means you’ll really need $90,000-$110,000 per year and $2.25 million in total.  However, assuming you use a 7% growth rate and the market actually returns ~10%, you can safely calculate your savings needs using today’s dollars and assume that you’ll have what you need in tomorrow’s dollars.

Accounting for Social Security and other factors

Of course, the odds are you won’t be living solely off of investments and savings. You may have employer pensions, rental income, and, of course, Social Security if you’ve been paying U.S income taxes. Accounting for these can affect how much you need to save. For example, the average U.S Social Security benefit in 2020 is about $1,500 a month/$18,000 a year, meaning if you have a $50,000/year goal, you would only have to save for $32,000/year. 

The Social Security Administration provides several useful calculators to help you figure out what your future benefits are likely to be. Of course, if you prefer to not rely on Social Security, given that it’s a government program subject to changes, you could simply save it as if it doesn’t exist and use it as a backup to cover any shortfalls or market downturns. 

Other savings instruments will be on a case-by-case basis, so you’ll have to account for any income generated by pension plans, businesses, or rentals. 

Using formulas and/or calculators to plan your savings

Identifying the total amount that you need to save is relatively simple. The math for figuring out how much you need to save on a monthly basis isn’t exactly astrophysics, but using an online calculator is probably easier. Googling “retirement calculators” should yield plenty of results, most of which let you plug in some information about your savings and retirement needs and tell you how much you’ll need to save to achieve your target. 

If you enjoy the math, though, here is the formula for figuring out how much you need to save each month (d) to reach your goal (A): 

d=A[i(1+i)n-1]

d = the number of your regular deposits ($8,000/year, for example)

A = the total amount saved in the end

i = the interest rate per compounding period (ex: 0.07 for yearly interest)

n = the number of compounding periods (ex: 10 years)

By solving for A instead, you can plug in your savings frequency and growth rate to see what varying your savings habits can do. 

A=d[(1+i)n-1i]

For example, if you want to calculate how much you need to save every year to reach $1,250,000 in 30 years at 7% interest, the equation will look like this:

$13,233=$1,250,00[0.07(1+0.07)30-1]

Meaning that you’ll need to save approximately $13,233 a year or $1,102 per month in order to reach 1.25 million dollars in 30 years. 

This formula can easily be adjusted for months if you multiply n by 12 and divide i by 12.

How to save

Retirement savings strategies are a whole topic unto themselves, but once you know your total target and your monthly savings needs, there are several basic principles to follow:

  1. Invest in your 401(k)s and IRAs first. The tax benefits from these accounts will save you quite a bit compared to conventional brokerage accounts. Don’t forget that just putting money into these accounts isn’t enough—you or someone else also needs to ensure that the money is being invested.
  2. Invest regularly, using automatic deposits and investing services if possible. 
  3. Track your progress and periodically check if you’re where you should be. 
  4. Start now! With compound interest, a few extra years can make a significant difference in the long run, so the sooner you start saving, the more growth you’ll see. 
  5. If you’ve started late, you’ll want to consider strategies like saving a much higher percentage of your income, retiring later, taking on some work post-retirement, downsizing your lifestyle, or moving to a cheaper place (or even moving internationally!)

Keeping it simple

Long-term financial planning is not everyone’s favorite hobby, but it is important. It also doesn’t have to be complex. Finding your retirement savings target can be as simple as following a few basic steps:

  1. Make a ballpark estimate of your desired retirement income (maybe around 70-85% of your target end-of-career income). For example, you currently make $60,000 a year and think that in retirement you could live as you want with $50,000.
  2. Multiply that number by 25 and/or some lower number like 7 or 10. This can be your approximate retirement savings target. E.g., $50,000 x 25 would be $1.25 million and $50,000 x 10 would be $500,000. $500,000-$1.25 million can be your target savings range.
  3. [Optional]: Multiply this number by the inflation multiplier that corresponds to the number of years you are from retirement. A 7% growth rate already accounts for inflation, but this gives you the actual number that you’ll probably end up with if your savings stay on track.
  4. Use either one of the formulas above or a retirement calculator to arrive at an approximate estimate of what you’ll need to save on a yearly or monthly basis. 
  5. Start depositing your savings into a retirement account to achieve your target.

While it may seem like slow going in the beginning, the long-term growth will pay off!

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