Just how much money do you really need for retirement?
One of the hardest financial questions you will ever face is figuring out how much money you will need in order to enjoy a comfortable retirement. While coming up with an appropriate answer can be a bit of a challenge, there are some general guidelines that you can use to help you refine your answer.
Save what you can and then decide what your retirement will be like
In trying to come up with a number for how much their clients need in order to retire, many financial advisors look at the issue completely backwards. It's easy from an analytical viewpoint to take what someone is spending now and then figure out how much you'll need in order to sustain that level of spending in the future, and that's why so many of the rules of thumb concerning retirement income needs are so popular.
The problem with that perspective is that it doesn't address the fact that most people intend to have completely different spending patterns in retirement than they did during their careers. For some, expenses will drop because they no longer have to pay the costs of working, instead living modest lives with inexpensive tastes. For others, things like expensive hobbies and extensive travel plans could make expenses rise dramatically.
The more pragmatic approach is to save as much as you reasonably can, invest well, and see how things work out. Then you can plan your retirement accordingly, spending more or less depending on how well your nest egg managed to grow. By using this approach, you can keep an open mind toward what your retirement will look like, avoiding the potential disappointment of falling short of planned dollar amounts and instead looking to live life to its fullest regardless of your financial situation.
How's your health?
Arriving at the ideal retirement number is always a guessing game, so my general advice is to be conservative with your estimates and build in as much wiggle room as possible. That way, if you get hit with an unexpected bill, then you'll be in a better position to handle it financially.
It’s probably a good idea to assume health costs will take a large chunk of retirement savings.
One of the biggest potential curveballs that retirees face relates to their spending on healthcare. A recent study by Fidelity Investments showed that the "average" 65-year-old couple is expected to spend $260,000 on out-of-pocket costs to cover medical expenses throughout their retirement. That's a huge figure, and it also doesn't include the cost of long-term care insurance. If you think you could wind up needed long-term care -- and an estimated 35% of people over age 65 will spend at least some time in a long-term care facility -- then you can bump up that figure by another $130,000.
Of course, a couple's actual spending on heathcare will vary widely based on a range of factors, but the takeaway from this study is clear -- paying for healthcare can be a real challenge for retirees. That's why the smart move is to play it safe and save as much money as you can possibly afford.
Work backwards to figure it out
An exercise that nearly everyone should go through every year or so is to estimate your retirement expenses and work backwards from there to determine how much money you'll need.
Many retirement experts say that the average retiree will need to replace 70%-80% of their income in retirement, since some expenses will fall, such as work-related costs like commuting, dry cleaning, or professional fees. At the same time, there may be other expenses that go up, including travel, entertainment and leisure, and even shopping. In other words, don't just assume you'll spend less money across the board. Think about the retirement you'd like to have -- and the costs related to the activities you intend to pursue -- and budget them in.
Next, subtract the income you'll get from Social Security and any pensions based on the age you plan to retire -- you should be able to get these estimates from your pension manager and the Social Security Administration -- and then use the 4% withdrawal rule to figure out how big your nest egg should be.
Here's an example: If you and your spouse will bring home $3,500 per month ($42,000 per year) from Social Security and you will need $60,000 per year to cover your anticipated expenses, you'll need to generate $18,000 per year from your retirement savings. According to the 4% rule, you'd need $450,000 in retirement savings to generate that much sustainable income (4% of $450,000 is $18,000).
So take the time to determine how much your retirement will cost and how much income you can expect from pensions and Social Security. Using the 4% rule, you can then determine how much you'll need to have saved up in order to enjoy a comfortable retirement.
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Story from The Motley Fool.