It seems like such a daunting task. The mountain climb to the summit of retirement is quite the hike, with many obstacles can send you tumbling down the trail.
Knowing you might need to save $1 million, $5 million, or maybe even more than that when you factor in inflation can make retirement saving seem impossible.
Since determining how much money you need to retire is an exercise in foretelling the future, it’s important to understand that coming up with a precise number is nearly impossible.
Fortunately, a ballpark estimate will be good enough, and that’s very doable.
Yet, if we take the time to break down saving for retirement into manageable monthly chunks, we might just be surprised at what we find.
One of the most important facets of retirement savings is consistency.
I would rather you save $500 per month every single month than $6,000 yearly if you remember to do it.
You are much more likely to see success by sticking to a set automatic plan for investing in your retirement.
We just need to know what that number is.
How do you do that if you’re 30 or 40 years away from retirement? There are retirement calculators on the web that you can use, or you can work it out manually.
How to Calculate How Much to Save Each Month for Retirement
Breaking down retirement into manageable pieces makes the task seem a lot easier.
Here are the eight things you need to know before calculating how much money you need to save each month toward your retirement. The sooner you start, the better it will be.
1. List Your Current Living Expenses
It can be very difficult to project your living expenses by the time you retire.
By contrast, it’s very easy to determine your current living expenses. And that’s fine for now, since you can make adjustments for your retirement in the next step.
List out your current living expenses, starting with your fixed expenses.
This group will include:
- Your monthly house payment
- Payroll taxes
- Retirement contributions
- Health insurance
- Debt payments
- Life insurance premiums
- Other savings plan contributions (savings, investment accounts, etc., payroll deducted or otherwise)
Next, list your variable expenses:
- Internet, cable, and phone expenses
- Vacations and travel
- Repairs and maintenance
- Out-of-pocket medical costs
Once you have all of these numbers listed, total them up.
The total will be the starting point to determine how much money you will need to live on when you retire.
2. Adjust Your Living Expenses for Retirement Factors
Once you have your list of current living expenses, it’s time to make adjustments based on the different living conditions retirement will bring.
Some expenses will need to be lowered, while others will need to be increased. Much will depend on what you project your circumstances to be by the time you retire.
Expenses you will need to adjust higher due to retirement are primarily your variable living costs:
- Entertainment: Retirement will bring more free time, and will likely cause this expense to rise.
- Vacations and Travel: Travel is a common goal of retirees, and the free time that retirement provides will make it more possible.
- Out-of-pocket Medical Costs: Because retirement also coincides with advancing age, this will be a major variable that must be anticipated.
Expenses that will probably be lower in retirement are mainly your fixed living costs:
- Monthly House Payment: This should drop if you plan to have your mortgage paid off, or if you plan to downsize to a smaller space or to a less expensive location.
- Payroll Taxes: These will drop when you are no longer working, though you will still likely have income taxes you will have to pay.
- Retirement Contributions: When you retire, you shift from saving money to withdrawing it, so this expense should disappear.
- Debt Payments: If you plan to be debt-free in retirement, you can deduct these payments.
- Life Insurance Premiums: This will be lower if you will have a paid-up policy by retirement, or if you decide that you no longer need life insurance.
- Groceries: This expense should drop if you have a family, and your kids will be grown and gone by retirement.
- Repairs and Maintenance: You might adjust downward if you plan to downsize your home or to go from two or more vehicles to a single vehicle.
Health Insurance could be either higher or lower in retirement. It could be lower if your current plan includes your children. Since they will not likely be on the plan by the time you retire, your premium could be lower.
But, there’s a long list of reasons why it could be higher:
- Early Retirement. If you retire before you qualify for Medicare at age 65, you will need a private health insurance plan, which will almost certainly be more costly than your current plan.
- Employer Subsidies Vanish. Many employers offer generous health insurance premium subsidies; the cost of Medicare plus a Medicare supplement could be more expensive than your current contribution to your plan.
- Need for Better Coverage Due to Age or Health. Health insurance premiums generally increase with age; you may need more comprehensive coverage than you have right now.
- Health Insurance Premiums Rising Faster than Cost of Living. It’s almost guaranteed that health insurance premiums will be substantially higher as time goes on.
- Changes in Healthcare/Health Insurance System. We don’t have a crystal ball and can’t predict future health insurance premiums or changes to laws. Just know that future prices will probably not decrease.
I’m not trying to scare you concerning health insurance considerations in retirement. But, it is a major “X” factor and one that will require special provisions.
Once you have adjusted for anticipated expense changes in retirement, you should have a monthly figure representing a reasonable estimate of your retirement living expenses.
Multiply that number by 12 to determine your annual living expenses.
3. Determine Your Nest Egg Goal
Of course, you need a goal in mind. Figuring out your retirement nest egg number is a completely different topic but an important one to calculate.
To come up with this number, you need to estimate how much you will spend in retirement as well as what you think inflation will average up until your death. Consider securities from the Treasury to protect against inflation, or you can get a little more speculative and try something like a goal or other stable materials and goods.
If you only calculate inflation until you retire, you may face some cash flow issues once you start withdrawing your funds. This is particularly important for those trying to retire super early, including those in their 30s and 40s.
It is better to aim too high and end up just fine in retirement than to aim too low and run out of money while you are still alive. Additionally, you need to avoid borrowing money from your retirement accounts, too, so you don’t create an opportunity cost of your funds staying in the market.
4. Calculate Your Expected Rate of Return
Next, you need to know what you expect your investments to return over your lifetime.
Since it is impossible to see into the future to determine what stocks and bonds will return, many people rely on historical returns. Over the last 50 years, stocks have returned about 9.73% and bonds around 5.11%.
Once you know what you think your portfolio segments will return, you should know what mix of investments you plan to keep. In other words, 9.73% stock returns sound great but meaningless if you only keep 10% of your portfolio in stocks.
Your expected rate of return is important because it will be used to determine how much money you need to be compounding over the years to reach your nest egg goal.
Just like you would rather aim too high with your nest egg number, it is much better to aim too low on your expected rate of return. Aiming low just means you will end up setting aside more money each month for retirement and end up with a larger nest egg than you expected.
On the other hand, if your expected rate of return turns out to be too high – say 18% per year – then you won’t put back enough money each month, and the result will be a woefully inadequate retirement fund.
5. Estimate Expected Social Security and Pension Income
It will give you a monthly amount, which you can multiply by 12 to get the annual amount. You can also register for an online Social Security account where you can track your expected benefits.
If you are covered by a traditional, defined benefit pension plan, check with your human resources department to get an estimated monthly benefit at retirement.
Again, multiply that number by 12 to get the annual amount.
6. Calculate the Income You Will Need From Investments
By deducting your anticipated annual income from Social Security and/or any pension income from your retirement living expenses, you’ll arrive at the annual amount of income that will need to be provided by your retirement investment portfolio.
For example, let’s say you will need $50,000 per year to live comfortably in retirement.
But, you anticipate a $20,000 annual Social Security benefit and a $10,000 per year pension. That means that $20,000 of income ($50,000 – $20,000 – $10,000) must be provided by your retirement portfolio.
Now you can calculate how large your portfolio will need to be to produce the investment income you need.
Of course, include your taxes as an expense, and try to plan for them to be as little as possible using dividends, long-term capital gains, and other methods.
7. Apply the Safe Withdrawal Rate
The safe withdrawal rate is mostly a convention that states that you can withdraw about 4% from a retirement portfolio while preserving its value throughout your retirement years.
It is, of course, based on the idea of a balanced portfolio, including an appropriate mix of both equity investments and fixed-income securities.
The overall rate of return on the portfolio must exceed 4%, and the difference is re-invested into the portfolio to protect it from inflation. As an example, if you earn 7% on your portfolio, you withdraw 4% for living expenses, and the remaining 3% stays in the portfolio to cover a 3% annual inflation rate.
In the example above, we’re using the $20,000 per year your investment portfolio must supply. You can calculate how much must be in the portfolio by the time you retire by dividing $20,000 by the 4% rate of return.
$20,000 divided by 4%, or .04, equals $500,000.
Another way to calculate portfolio size that may be simpler is just to multiply the amount of income needed by 25. That will also give you $500,000.
How precise will that number be? Once again, we’re trying to predict the future here, which is always an inexact science.
Some even suggest not to withdraw in particularly bad years, so you have more time to allow those funds to regain their previous highs before you take them out.
But, this does give you a ballpark estimate of how much money you need to retire, and you can use it as a starting point. Between now and the time you retire, you must make any necessary adjustments.
8. How Long Will Retirement Saving Last?
The last piece is how long you expect to be saving for retirement. Will you work until you are 60? 65? Longer?
The period between now and when you stop saving for retirement and begin enjoying retirement will impact the calculations considerably. The longer you have time on your side slowly compounding your portfolio, the larger your nest egg will be.
A 30-year-old individual setting aside $5,500 per year into a Roth IRA (plus $1,000 catch-up contributions once they reach age 50) and earning a consistent 7% return will have $840,412 if they retire at age 65. The same person will only have $570,685 at retirement if they hang it up five years earlier.
The Retirement Seesaw
Think of your retirement nest egg goal as the result of a seesaw.
On one side of the seesaw is your expected rate of return. The other side holds how long you will save for retirement and how much your cost of living will be when (and where) you retire.
There are many combinations of the two variables that will get you to your goal:
- You can have high annual returns and only need low contributions.
- You can have high contributions to your retirement funds and need a low rate of return to achieve the same result.
- You could have average contributions and average returns and still get the same result.
We’ll also assume you are saving for the same period in our comparisons. You need to figure that out first before balancing the seesaw.
How Much Money to Save Each Month for Retirement
Once you know your retirement goal amount, your expected rate of return, and how long you will retire, then calculating how much you need to start saving and at what age is relatively easy.
Adding these savings to your investments (and not the other way around) is in your family’s best interest; you do not want to live your retirement years burdening your children for money to help you survive.
You can use an online calculator or an Excel spreadsheet with a Goal Seek function. Just work out a formula that builds in the compounding of a certain amount each year.
In my spreadsheet, using some basic assumptions like linear portfolio growth, it turns out that with a 7% rate of return, our 30-year-old investor that wants to retire at age 65 won’t make it to $1 million with just $5,500 contributions plus $1,000 in catch up contributions at age 50.
Instead, he’ll need to find a way to set aside $6,578.93 each year and then $7,578.93 once he hits age 50. If he does these things, he will retire with $1 million.
Once you calculate how much you need to save per year, just divide by 12, and you’ll have how much you need to save per month.
Have you figured out how much money you’ll need to save per month to retire? Leave a comment!