Calculating Your Retirement Needs
Today let's talk about something that's often overlooked but absolutely crucial—figuring out how much you'll actually need to retire comfortably. Retirement might seem like a distant horizon, but the sooner you crunch the numbers, the smoother your sail into those golden years will be. Here’s your step-by-step guide:
Step 1: Estimate Your Retirement Income Needs
First things first, let’s look at your projected expenses. Consider the following:
You'll no longer be funneling a chunk of your income into retirement savings.
No more work means no more (or far less) commuting expenses.
If you’ve played your cards right, you might be mortgage-free by then.
Life insurance? Maybe not a necessity if you don’t have dependents anymore.
Put all that together and a good rule of thumb is you'll need around 80% of your current income to maintain your lifestyle.
Step 2: Don’t Rely on One Source
Social Security might be the first thing that pops into your head, and sure, it's a nice cushion. But what a lot of people won’t tell you is that the amount you'll receive depends on various factors like your age when you start withdrawing benefits and your pre-retirement salary. Don't solely rely on Social Security. It won't cover all your expenses, and honestly, who knows if it'll even be around when you retire?
Step 3: Take Inflation Into Account
Inflation is an obnoxious detail that can throw a wrench in your plans. The buying power of a dollar today won't be the same down the line. Your retirement savings might look awesome now, but they need to grow enough to outpace inflation. If your income and retirement savings aren't increasing by at least 3-4% per year, your net value's actually dropping. Keep your eye on this!
Assess Your Tax Management
Remember to keep taxes in mind when it comes to withdrawing your retirement income. Money withdrawn from Roth IRA’s and Roth 401ks are not taxable, but money withdrawn from 401ks and traditional IRAs are. The tax percentage is based on your ordinary income tax rate. So if you’re in the 22% tax bracket in retirement, you’ll pay up to 22% on funds withdrawn from those accounts. For more information on how tax brackets work, check out this post.
Calculate Your Perfect Retirement Number
Okay so what’s your perfect number—the amount you need to save to live comfortably for at least 30 years? The 4% rule is the best guide we have for that right now. The gist of this rule is that you can take 4% of your retirement savings out in the first year of retirement, and then every year after you can take that plus a little more out to adjust for inflation. Following this rule, you shouldn’t have to worry about running out of money for at least 30 years.
To find your target savings, use this formula:
Annual income needed X 25 = Target Savings
This number probably sounds daunting but remember… compound interest is your friend and will help tremendously the longer your money sits in that retirement account.
