There are a lot of sites that help you determine how much you need to save for retirement but I have never been comfortable with them because they usually don’t share the logic behind their calculation. Also, there are really two numbers you need (1) how much money you need per year, and (2) how much you should have in your retirement account. To help double check the calculator, here are some steps you can follow to do your own calculations.
It is important to note that these steps do not take into account all the little caveats that may be unique to your situation; however, the method does offer a good starting point for your retirement planning.
Determine Your Retirement Needs
1. How Much Money You Need Per Year During Retirement
If you think about what you’re able to live on today, you can figure out approximately what you can live on in the future (in today’s dollar)
You will likely spend less on:
- Retirement saving – Let’s pretend that you make $50,000 per year and save $10,000 a year for retirement. When you retire, you don’t need to save $10,000 a year anymore, so you could potentially live on $40,000 per year.
- Housing – If you are a homeowner today, there is a good possibility that you won’t need as much money for housing. For example, our escrow (insurance and taxes) is about 30% of our total monthly payment. By the time we retired, the house would be paid off saving us 70% of the housing expenses.
You will likely spend more on:
- Medical Expenses – As you get older, you tend to spend more on medical issues, or you might be paying for your own insurance instead of participating in your employer’s plan.
- Extracurricular Activities – Working all the time doesn’t leave a lot of time for you to spend money on activities and travel. When you retired, hopefully, you will be in a better position to spend some quality time traveling and doing activities.
Let’s assume everything balances out and you can live on $50,000 a year.
80 Percent Rule for Retirement
There is also a popular rule of thumb among financial planners that estimate your retirement income equal to 80% of your current income will give you the a standard of living that is substantially similar to what you are experiencing now.
You can also use this rule to quickly determine your retirement income amount.
2. Adjust for Inflation
Now we have to adjust that $50,000 for inflation. According to Bureau of Labor Statistics, the average inflation rate for the past 30 years has been about 3% (I am approximating the value based on the chart). So we can calculate what we need in…say 30 years with the following formula:
Retirement Income = Today’s $ * ((1 + inflation rate)^ Number of years to retirement)
Retirement Income = $50,000 * (1.03 ^ 30)
Retirement Income = $121,363
This means you’ll need about $121,500 30 years from now (inflation adjusted and rounded up).
You can also cheat and use a Future Value Calculator, like this one on Investopedia.
Determine How Much You Need to Save for Retirement
Using the fairly common The Multiply By 25 Rule and the 4 Percent Rule, we can continue our calculation and determine how much we need to save. This is ideally how much we should have in our retirement saving right when we are getting ready to retire.
Target Retirement Saving = Retirement Income * 25
Target Retirement Saving = $3,037,500
I need to save about $3 million to begin retirement!
Well, don’t fall off the chair just yet…
Using this Investment Calculator at Bankrate, you could potentially save $3 million in 30 years by investing $1,800 a month in the Stock Market (assuming 9% annualized return), AND we also made some assumptions
- We are assuming you have $0 saved right now.
- We are not factoring in other sources of income or side hustles that you might be doing.
- We are not counting your Social Security benefits.
- We are not counting other retirement benefits…pension may be?
Comparing Against Online Calculators
Vanguard Retirement Income Calculator
I plug in same numbers as our scenario in Vanguard Retirement Income Calculator and got the following result.
The main issue I see with Vanguard’s calculator is that it doesn’t adjust for inflation, so you might be falling short by the time you hit retirement age.
SmartAsset Retirement Calculator
You can also use the SmartAsset Retirement Calculator below. Again, plug in similar numbers in their calculator. The good news is that this one takes inflation into consideration (you can make more adjustments with the full version Retirement Calculator).
SmartAsset calculates retirement income requirement at a much higher amount of $169,560 per year, yet it indicates that we only need a saving of $552,178 because they are assuming you have other sources of income such as Social Security, pensions, savings and investment drawdowns (whereas we don’t in our calculation).
It is nice to be able to search online and plug in the numbers to see what you need for your retirement savings, but I think it is vitally important that you understand how to calculate the numbers on your own because each calculator uses different set of rules and assumptions. If you don’t try and compare several different calculators, you might be led into a false sense of security that the numbers presented are good and accurate.
Pinyo is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.