One of the reasons saving for retirement can seem like an impossible task is because many of us set our expectations too high. In recent main-stream financial media, some experts recommend saving up as much as $2 million dollars before even considering retirement. Don’t get me wrong! $2 million dollars would make a great nest egg and provide quite a bit of financial security.
But is it absolutely necessary to save up this much? This question might be especially important if you’re short on savings, just getting started late in the retirement planning game, or ran into some financial challenges along the way. No matter what the reason is, you can rest assured that numbers like this are more of a “one size fits all” type of suggestion, and that your actual savings goal may be quite a bit different from this.
To find out, here are some areas you should consider to if your retirement savings goals could be reduced.
Build Your Retirement Savings Goal Around Your Numbers
While financial articles are helpful for mainstream advice, no individual person should ever base their savings goals around something they read off the Internet. Each and every person (or couple) is different with different needs. Your number should be unique just like every other aspect of your life and personality. The best way to do this and start the retirement planning process is to first examine what your true spending needs are. In other words, how much money per year will you need to make you satisfied?
To put this into context, let’s use a good rule of thumb known as the 4 Percent Rule. The 4 Percent Rule states that a retiree should be able to withdraw approximately 4 percent of their starting portfolio year after year for at least 30 years without nearly any fear of running out of money.
Let’s see what that would mean for the mainstream advice savings target of $2 million dollars. A nest egg that size would produce retirement income of $2,000,000 x 0.04 = $80,000 per year with inflation adjustment. Now, ask yourself the obvious question: Do you really need this much?
You might say “yes” or “no”. It’s really up to you; as it should be. Let’s suppose for a moment that you said “no”, and that you and your spouse would actually be just fine living off of $60,000 per year. If this is the case, then you could use the 4 Percent Rule in reverse to figure out that you might need to save towards a much lower target instead: $1.5 million.
If you said “yes”, the rule works the same way as well. To incredibly simplify the retirement planning math, you could think of every $10,000 of retirement income that you need from your nest egg as being another $250,000 that you need to save.
Ways to Tweak Your Savings Goals Even Further
Remember that the whole reason behind creating a retirement savings nest egg is because you need it to produce income.
Therefore, if you have OTHER sources of income, you might not need to save up as much. Consider the following:
- Will you have any other sources of income available to you when you retire? A pension from a former job? Alimony? Settlement? Etc?
- Are you factoring in Social Security payments? Most working Americans can start taking payments at age 62. Social Security estimates the average monthly benefit as being $1,360.
- What about the possibility of making some money on the side during retirement? Could you do some small jobs for a little part-time income? Even something as small as $1,000 to $2,000 per month could cut your savings needs down substantially; not to mention gives you a great outlet for social interaction.
- Could you possibly become a landlord and produce rental income?
Your Expenses May Change Over Time
Another point to consider is that the amount of money you require now may be a lot different than the amount of money you require in the future. This is because as our lives, family and housing needs, and job status changes, so do our expenses.
- When you’re retired, you won’t have to save for retirement anymore. That means that if you’re saving 10% in your 401(k), you won’t need to replace that.
- When you’re retired and paying federal taxes, you won’t be paying FICA (Social Security or Medicare taxes). That means you’ll save another 7.65%.
- Will your house be paid off by the time you retire? Most people spend about 20 to 25% of their income on paying off the mortgage every month. If you can manage to work down your mortgage by then, this will be income you won’t need to count on replacing.
- Could you drive your car for a few more years and go without car payments? Doing this might save you anywhere from $200 to $1,000 per month (depending on what kind of vehicles you drive and how many you have).
Of course, there are many more ways to cut expenses. Your focus should be to pinpoint what you think your spending might look like and see how it can better be optimized.
What you should do:
- Make a list of your actual expenses as they are right now.
- Evaluate each one and determine if it will still be an expense in the future.
- Tack on any extra items you think you might have in the future (such as additional medical expenses).
- Add everything up. Then factor in an additional amount for the taxes you will pay out of pocket.
- Use this value in connection with the 4 Percent Rule and any other sources of income to determine what your nest egg savings target should be.
Though it may not be perfect, doing this exercise will give you some idea of your starting point and where you should be heading. Together with discipline and moderation, you’ll soon find that you can be in the driver’s seat when it comes to money.