How much money you’ll need and how to ensure you’ll have it
Why saving for retirement is important
Before we get into how much you might need to save for retirement, it’s worth reviewing why saving for retirement is important.
If you asked most people if saving for retirement is important, they would likely say “yes”.
While most people believe that it is important, few people make it a priority to actually save enough money to retire at a young enough age to enjoy their retirement.
There are a number of reasons for this.
- Most people don’t know how much money they will need in retirement and even if they did, they don’t know how much they need to save right now to have the money they will need in retirement.
- As humans we are naturally inclined to procrastinate. Especially when we won’t feel the consequences of our procrastination until many years in the future.
- So many people live paycheck to paycheck and that keeps them in a short term money mindset. If you spend half your day worrying about how you’re going to pay this month’s rent, it’s difficult to worry about saving for the future.
- I’ve even heard some people say that they wouldn’t mind working forever. They love their job and don’t see themselves ever retiring, so saving is not a priority.
Here is the problem with that kind of thinking. It’s easy to say you don’t mind working forever when you are young and healthy. I am 31 years old and I love what I do. I would keep doing it forever, If I could remain a healthy 31-year-old forever.
But, I can’t. One day I’ll get old and my health will begin to fail. Working may be a lot less fun when it hurts to simply get out of bed in the morning. I have to be realistic and come to terms with the fact that there may come a day where I don’t want to do any work at all.
If I’ve reached retirement age with very little savings and am unable to work what would become of me? I would have to rely on my family and the government to support me. The thought of being that type of burden stresses me out.
That is why it’s important for me to save for retirement. If nothing else, to at least provide me the option to retire by a certain age and live financially independent.
How much retirement income do you need?
To know how much you need to save for retirement, you need to know how much income you think you’ll need in retirement. Since the point of saving for retirement is to provide you income without working, you need to know how much income you are saving to replace.
There are two ways to answer this question.
- The cost approach.
- The income replacement approach.
The cost approach would be to use the 25 times rule, which is a rule of thumb that states that you need to save 25 times your annual expenses to retire.
If you estimated that you could comfortably live off $50,000 per year in retirement, you would need to save $1.25 million ($50,000 X 25) to safely fund your retirement.
The trouble with the cost approach is that many people have no clue how much they will spend in retirement. It’s easier to imagine how much future income we would feel comfortable with than to know how much we will spend in retirement.
The income approach would look at how much of your pre-retirement income you would like to maintain in retirement. The assumption in many financial plans is to aim to replace 70% of your income in retirement.
If your pre-retirement income was $50,000 and you wanted to replace 70% of that income in retirement, you would need $35,000 per year in retirement.
How much money do I need to provide that income?
The next question is, how much money do I need to provide a $35,000 income during retirement? Luckily, we can actually use the 25 times rule to answer this question.
If we substitute the word “income” for “expenses”, the 25 times rule tells us that we need to save 25 times our desired retirement income to fund our retirement.
In this example, you would need to save $875,000 to fund your retirement. We could then use the 4% safe withdrawal rate to provide us $35,000 ($875,000 X 4%) of income during retirement.
So, you have figured out how much income you would like to have in retirement and how much money you need to provide that income. Only one question remains.
How much do I need to save each month?
This is where I run out of generalizations and “rules of thumb” to give you an approximation of how much you need to be saving every month. The truth is, it depends on a number of factors.
- Your current age.
- The age you want to retire.
- How aggressively you invest.
- What existing retirement savings you have right now.
- Whether you have a pension or not.
I can demonstrate with an example.
Let’s assume the following.
- Current age: 37
- Desired retirement age: 65
- Desired retirement income: $35,000
- Current retirement savings: $70,000
- Assumed investment returns: 5%
I’ll also assume that you do not have any kind of workplace retirement savings. If we take all that to be true, you would need to save $2,607 every month to safely fund your retirement.
If you change any of the variables above, that figure changes.
- If you were 27 rather than 37, you would only need to save $1,267 per month.
- If you wanted to retire at 55 rather than 65, you would need to save $5,772 per month.
- If you currently had $200,000 saved rather than $70,000, you would need to save $1,887 per month.
Working out these details can be pretty complicated, especially if you aren’t able or willing to pay for a financial advisor to help you work out the math.
That is why I will be releasing a personal finance course that will include a custom-built Excel workbook that will crunch the numbers for you.
You simply enter the variables discussed above and the excel workbook will calculate exactly how much you need to save each month to fund the retirement you deserve.
The course will be launching January 2020, to reserve early access, sign up for my free mini-course, here.