A million dollars is a lot of money to anyone, but we’re long past the days when it could buy you a luxurious retirement. Most workers today will need a lot more to ensure a comfortable future, especially if they expect their retirement to last two or more decades.
Guessing isn’t a great idea when your future financial security is on the line. Instead, let’s talk about how to calculate what you’ll actually need for retirement.
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Why isn’t $1 million enough?
A $1 million nest egg is definitely a great start, and in the past, it would’ve secured you a nice retirement. But there are a few important factors that have made retirement increasingly expensive.
First, people are living longer. In the past, someone retiring in their mid-60s may have only had about 10 more years to live. But now many seniors are living into their 90s or beyond. Some might need their retirement savings to cover three or more decades of living expenses, and $1 million just isn’t enough.
Inflation is also at fault here. As living costs get more expensive, you have to spend more to maintain your current lifestyle. You’d need $1.665 million today to have the buying power $1 million gave you 20 years ago, and that’s only going to get worse over time.
Then there are the changing dynamics of retirement savings. Retirees in previous generations could count on pensions from their jobs and a Social Security benefit that replaced about 40% of their pre-retirement income. Today, pensions are rare, and Social Security’s future is uncertain. Benefits won’t go away, but future cuts could put an even bigger strain on workers who already shoulder the bulk of the retirement savings burden.
How do you calculate what you actually need for retirement?
A general rule of thumb is to assume you’ll spend about 80% of your pre-retirement income in retirement. But you have to adjust this based on your retirement goals. You might need less if you plan to stay close to home and work a part-time job, or more if you plan to travel the world. Consider your plans for retirement and estimate how your expenses might change between now and then. When in doubt, it’s better to figure a little too high rather than too low.
You also need a rough idea of when you’d like to retire and how long you expect to live to determine how many years of savings you’ll need. Choose any retirement age you like to start with. You can always change this later if your original plan isn’t feasible. For life expectancy, draw on personal and family health history to estimate this. But if you’re reasonably healthy, you probably want to plan to live until at least 90.
From here, there are a few ways you could go. A retirement calculator can give you a personalized estimate based on the life expectancy, retirement age, and estimated expenses you calculated. It can also tell you how much you need to save per month to reach your goal.
When calculating this, it’s best to be conservative about your investment growth. Figure 5% or 6% per year just to be safe. Your investments might grow more quickly than this, in which case you could retire earlier. But if that doesn’t happen, you won’t have to worry about your plan getting derailed.
Another option is to use the 4% rule. This strategy says you should save 25 times your estimated annual retirement income. Then, you withdraw 4% of your savings in the first year of retirement and then the same amount next year, plus a little more to account for inflation. It’s supposed to help your savings last 30 years.
But it doesn’t always work. Some prefer a 3% or 3.5% rule instead. And others prefer a more flexible retirement withdrawal strategy that enables them to take out more money in some years and less in others to suit their spending habits.
Try out one or both of the approaches above to see where your retirement savings goal ends up. You may need to adjust it over time, especially if you’re a long way from retirement. Schedule time each year to review your retirement plan and adjust your savings strategy as needed to stay on track for your goal.
