One of the most common questions people ask me is “How much do I need to save for retirement?” An accurate answer requires that I ask a lot of questions, so I understand their particular circumstances and assumptions about the future. To begin with, it’s necessary to know how much they’ve already saved, their risk profile and time horizon, and the type of retirement lifestyle they want. It also requires a conversation about future rates of return, interest rates, inflation and income taxes. Those details are just the tip of the iceberg. The subject gets pretty complicated, pretty quickly.
If you’re wondering how much you should save, let me offer you a simpler answer that will provide a ballpark figure that many people have found useful.
Begin with the amount of monthly income you want in retirement. If you don’t know, and your current income provides a comfortable living, use that number. Let’s say, the figure is $10,000 per month. It takes savings of approximately $2 million to provide a $10,000 monthly income. But remember, you will probably have guaranteed income coming in from Social Security and you may have income from a defined benefit pension plan. If so, you won’t have to rely on personal savings alone to produce that $10,000. Your savings just has to make up any shortfall between the guaranteed income coming from other sources and the total retirement income you’ve targeted.
How long will you have to make up this shortfall? In other words, how long should this income last so you won’t outlive it? In my opinion, it is wise to plan for at least 30 years of retirement given today’s statistics on longevity and continuing advances in medicine.
The goal would be to build an investment portfolio that permits 5% annual withdrawals to cover the shortfall for life. A 5% annual withdrawal may be a bit aggressive, but it is possible with the right strategies. While 3% or 4% of savings is generally quoted as the ceiling for annual withdrawals, I‘ve found the percentage doesn’t provide sufficient income during the first phase of retirement. At this point, retirees tend to be healthy and active. They’re spending money traveling and pursuing new hobbies. I think a 5% annual withdrawal rate works far better for most of my clients at this stage of life. Keep in mind determining your withdrawal rate will also depend on if you want to spend down your principal or not.
Most of my clients have needed more income in the early years of retirement and spent less as they aged. While healthcare needs can increase significantly over time, the proper advance planning (a good Medicare supplement plan and long-term care insurance policy, for example) can relieve the burden on personal savings.
All in all, a plan for building savings or producing income has to be realistic to be effective. Experience is a great teacher, and it’s shown me that people are much more likely to follow “rules” that are reasonable. Sterile, academic plans look good on paper, but they are often too rigid to be practical.
People often wonder if they can establish their savings goal by using a retirement calculator they can purchase or access free online. Using a tool like this is better than nothing at all, but all calculators share a common problem: They lack wisdom. They don’t reflect the knowledge gained from working with people who have retired. They don’t account for the emotions, family situations, and unknowns that will occur. Just imagine who’s programming these calculators. Most of them are young adults who haven’t had the life experience and wisdom that you do.
Using a retirement calculator can be expedient, but people like you —in their 50s, 60s and older—deserve the wisdom a financial advisor can offer. We’ve worked with hundreds of clients who’ve already been where you’re going. When things were very good —or very bad—we advised against letting emotions dictate financial decisions. Or when there was a family situation that left a client feeling very much alone, we assured them that others who had gone through a similar experience had found their way through it.
So, if you want to know how much to save for retirement, look for an answer based on facts and wisdom.