If everyone got a dollar every time they wondered, “How much do I need to retire?” we’d all be a lot closer to retiring.
Joking aside, there’s no one answer to the perplexing question of how much you really need to retire. It’s really a personal calculation based on numerous factors, including your income, your age, how much you’ve already saved and when you can tap retirement and Social Security benefits.
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How Much Do I Need to Retire, Really?
The amount of money you need to save for retirement depends largely on your goals, health and lifestyle. However, one convenient rule of thumb suggests that an individual will likely spend 80% of their current income each year in retirement. So, if you earn $100,000, you’ll need about $80,000 per year when you retire.
This figure is flexible and can be adjusted based on the amount of Social Security you can claim and how much your retirement lifestyle might cost. You might need more income if you’re planning to retire and start a small business or less if you’re planning to downsize, work part-time or take on a roommate. You may want to take into account your likely health or medical expenses and whether your retirement nest egg is meant to cover two people or one.
It’s worth spending some time, and perhaps having some candid conversations with your spouse and family members, about your retirement plan. The amount you think you need may be different than the amount you actually will need. It’s important to explore the options since there are different ways to slice this pie.
The 4% Rule
How much do you need to retire? To understand the amount of total savings you might need if you’re aiming to replace 80% of your income each year, you can use the 4% rule. This rule of thumb recommends you withdraw no more than 4% of your total retirement savings to cover your annual expenses. The theory behind this rule is that by withdrawing a small percentage of your nest egg each year, you can leave the bulk of your portfolio intact and hopefully grow it steadily over time.
So if you consider your desired annual income of $80,000 and subtract, say, $20,000 in annual Social Security benefits (more on Social Security below), you would need about $60,000 to come from savings or other income.
Then, divide this target income amount by 4% to get the approximate total you’ll need to save. For example, for a target annual income of $60,000, divide $60,000 by 4% (60,000/0.04), you get about $1.2 million.
Target Retirement Savings By Age
Because lifestyle, standard of living and individual costs can vary so widely, there’s no exact recommendation for how much different age groups should have already saved for retirement. However, once again, there are some useful guidelines.
Are You on Track?
The rules of thumb above can help you benchmark whether you’re on track for retirement. However, it’s also important to factor in your personal financial situation as well as your retirement goals to get a handle on your individual needs. Depending on your personal circumstances, you may need to save more or less.
Give yourself an honest assessment of your financial present by doing an inventory of your current expenses, income, taxes and savings. Which expenses do you expect to carry over into retirement? Which won’t?
For example, perhaps you have a mortgage that you’ll pay off before you retire, so you won’t need to factor that into your retirement income needs. Do you have enough income to meet your savings goals? How much have you already saved in your retirement, brokerage and savings accounts? You can subtract the amount you’ve already saved from your total goal.
Understanding the Role of Social Security
Social Security benefits can provide a vital supplement to your retirement income. However, it’s critical to understand that the amount of your benefit will vary depending on your age. The earliest you can start receiving Social Security benefits is age 62; however, your benefits will be reduced by as much as 30% if you take them that early — and they will not increase as you age.
If you wait until your full retirement age (FRA), you can begin receiving full benefits. Your full retirement age is based on the year you were born. For example, if you were born in 1960 or later, your full retirement age is 67. You can find a detailed chart of retirement ages at the Social Security Administration’s website.
But here is the real Social Security bonus: If you can put off claiming your Social Security benefits until age 70, perhaps by working longer or working part-time, the size of your benefits will increase considerably.
Choosing From the Different Types of Retirement Plans
There are a number of tax-advantaged retirement accounts that can help you meet your retirement savings goals:
1. 401(k) Plans
A 401(k) plan is an employer-sponsored retirement plan. Contributions are made with pre-tax dollars, which lowers your taxable income for an immediate tax break. In 2021, individuals can contribute up to $19,500 each year, with an additional $6,500 for those age 50 and up. Funds are typically taken directly from your paycheck to make savings automatic.
Employers will often offer matching contributions, and employees should typically save enough to meet the matching requirements. After all, it’s essentially free money and can boost your retirement savings.
Investments inside 401(k) accounts grow tax-deferred, and withdrawals in retirement are taxed at your normal income tax rate.
Account holders who leave their job or are laid off at age 55 or older can make withdrawals from their 401(k) without paying an early withdrawal penalty. Otherwise, individuals must wait until age 59-and-a-half. Your 401(k) plan is subject to required minimum distributions (RMDs) once you turn 72.
2. Traditional and Roth IRAs
In addition to saving in a 401(k), you can also consider a traditional or Roth IRA. To help decide which one works for you, let’s look at the differences between the two:
- Traditional IRA. With a traditional IRA, contributions are made with pre-tax funds and grow tax-deferred inside the account. Withdrawals for a traditional IRA are taxed at ordinary income tax rates. Withdrawals can be made at age 59-and-a-half without penalty. Early withdrawals, though, are subject to both income tax and a 10% penalty. Traditional IRAs are also subject to RMDs.
- Roth IRA. Roth IRAs, on the other hand, are funded with after-tax contributions, so there is no immediate tax break. However, money inside the account grows tax-free, and withdrawals are also tax-free in retirement. Because you’ve already paid taxes on the principal (the amount of all your contributions), those funds can be withdrawn penalty-free at any time — but if you withdraw earnings as well, you could incur a penalty.
While the idea of tax-free retirement income is pretty appealing, Roth accounts come with several rules and restrictions, most notably income limits. Before opening a Roth, be sure you understand the terms.
Contribution limits for both traditional and Roth IRAs are $6,000, or $7,000 for those age 50 and up.
Asking yourself, “How much do I need to retire?”, is such a common question, yet it doesn’t have a one-size-fits-all answer. Determining the amount you’ll need to cover your expenses in retirement requires weighing various personal and financial factors, including how much you’ve saved and estimating how much you’re likely to need in the years to come.
Fortunately, there are some basic rules of thumb that can help you reach a potential target amount. While these figures aren’t set in stone, they can provide a reasonable ballpark to help you start planning, saving, and investing.
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Update: The deadline for making IRA contributions for tax year 2020 has been extended to May 17, 2021.
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