Saving for retirement can seem daunting. It seems impossible to save up the millions of dollars that will be needed for you to live a comfortable and secure retirement. Luckily, if you start early and put interest on your side, instead of against you as many people do by racking up debt, you can get to your goal with patience and persistence. The first step is calculating how much you need in retirement and then the next step is to calculate how much you need to be putting away each month to get there.
Calculating how much money you’ll need in retirement to maintain your current lifestyle is fairly simple:
1) Find your current income from all sources. If your are relatively new to your career and you expect a higher salary due to promotions or getting better jobs, adjust your current salary accordingly to the salary you expect to make later in life. One option to get a good number is to use a website to find salaries for people in your career path right now who have 20-30 years experience (or some higher income, if you want to have a lifestyle better than you currently have in retirement). You want the current earnings for those careers right now, not in several years.
2) Go to an investing or saving calculator (there is a good one in the links to the right) and put in your current earnings in the initial investment line, 3% for an interest rate, and the number of years to retirement in the investment term line. Compound yearly and at the end of the period. Press calculate – the number produced should be close to your salary at retirement, including inflation.
3) Multiply the result by 20, record the number. Then, multiply the original number by 30 and record that number. This gives you the range of assets you’ll need at retirement to replace the income you’ll be making. The low number assumes you can withdraw 5% per year from your savings each year, while the higher number assumes you can withdraw only 3.3% from your savings. The true number will lie somewhere in between. In actuality, if you make the high number, you’ll be able to invest more aggressively and be able to withdraw closer to the 5% number, where if you make the lower number you’ll have to be more careful and withdraw closer to the 3.3% number, so shoot for the higher number.
The next step is to determine how you’re doing. Basically, where you are on your retirement path and what you need to do to make your goal. To do this:
1) Add up your current savings, investments, and other assets. Note that assets are things that hold their value or increase in value, and preferable pay you an income (don’t include your home equity unless you plan to sell and downsize). This is your current net worth.
2) Put your net worth in the in investment/savings calculator as the current value or starting value.
3) Put 10% in for your expected rate of return, and put in the number of years you have until retirement. Guess a monthly payment of $500, then, hit calculate. Iterate up and down on your monthly payment until the final value matches your retirement goal. When they match, the monthly payment you have inserted is the amount you need to be saving each month to reach your goal.
Let’s look at an example. Let’s say that you’re 35, have an income of $57,000, and expect a couple of more promotions before you retire, so you think you may make $80,000 at retirement. Let’s say you have $60,000 in your IRAs and 401k, a few bank accounts, and a modest investment account. You plan to retire at age 70. Here’s what your investment calculator would look like:
Starting Balance: $80,000
Annual Rate of Return: 3%
Monthly Contribution: $0
Years to contribute: 35
Calculate Balance in: 35 years
Result: $225,109
So, you should expect that your final salary will be about $225,000 in 35 years, which will buy about what $80,000 per year buys today. To find the amount you will need to have saved up to generate this income, you multiply your future income by 20 and 30:
20x: $4,502,180
30x: $6,753,270
You should target $6.7 M in retirement savings, just to be safe.
Now, to calculate how much you need to save each month, here’s what the investment/savings calculator would look like on the first iteration:
Starting Balance: $60,000
Annual Rate of Return: 10%
Monthly Contribution: $500
Years to contribute: 35
Calculate Balance in: 35 years
Result: $3,474,907.19
This is below your goal, so you would increase your monthly contribution amount. Doing this a few times, you get the result:
Starting Balance: $60,000
Annual Rate of Return: 10%
Monthly Contribution: $1420
Years to contribute: 35
Calculate Balance in: 35 years
Result: $6,766,226.93
This is close enough to your goal to use. You would need to be putting away $1420 per month. Note, there are other calculators that calculate the monthly payment needed to reach a goal that you could use as well. It doesn’t take too many iterations, however, so the one I used is good enough if you don’t make this calculation too often.
If you are saving 15% of your salary in a 401k or other retirement account, as most people should, you’ll already be putting away $750 per month. If you have a matching amount from your employer, you might get another $150 per month, so you are putting away $900 and only need to come up with another $520 per month. Sound impossible? It really is possible with just a few sacrifices. In the next post, I’ll discuss ways you could go about hitting this savings goal.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.