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Economists have been sounding alarm bells about the precarity of social security and pension plans for years now. The uncertainty surrounding old-age payouts is part of the reason financial planners tend to stress the importance of saving for retirement. But how much is enough, and how can you reach your savings goals without upending your regular budget?
Let’s break this down.
Financial planning experts often cite two common rules of thumb. One offers a ballpark figure of how much money you will need to live out your life in comfort, while the other provides a general blueprint for step-by-step saving to reach specific goals.
To figure out how much money you will need to maintain a comfortable retirement, look at your pre-retirement, pre-tax annual income. The rule of thumb is that you will need to generate 80% to 85% of that total to maintain your current lifestyle. Thus, your savings will need to bridge the gap between that figure and the amount you can expect to receive from your pension benefits or social security plan.
To keep the numbers easy, let’s say you make $100,000 a year and you’ll be entitled to $40,000 a year in pension or social security benefits. That means you’ll need about $85,000 a year to maintain your lifestyle, which means you need to come up with $45,000 a year on top of your retirement benefits. Assume you’ll retire at 65 and life to the ripe old age of 95. That means you’ll need a nest egg of $1.35 million to get there.
The other rule of thumb says you should stash away 10% to 15% of your annual pre-tax income for your retirement plan. If you stick to your plan and never miss making a scheduled contribution, the magic of compound interest will make the numbers work, provided you start saving early enough.
Because compound interest is such a powerful financial accelerator, you’ll benefit by starting your retirement savings plan as early in life as possible. The ballpark figure of 10% to 15% of your pre-tax income applies if you begin while you’re in your 20s. It rises sharply if you wait until your 30s for 40s to start making contributions.
This CNN Money guide offers a formula to help you calculate your savings needs no matter what stage of life you’re currently at. It recommends setting aside $15 to $20 in retirement savings for every dollar you’ll need to bridge the gap between your pension benefits and your annual income needs.
For instance, if you need $50,000 per year to meet your lifestyle needs and you’re due to get $20,000 per year in pension benefits, you’ll have an annual gap of $30,000. Multiply that by 15 or 20 (we used 20) to calculate your retirement plan needs of $600,000. Then, annualize that figure by determining how many more working years you have left to tally up your annual savings requirements. If you’re 45 and you want to retire at 65 with $600,000 in savings, you’ll need to squirrel away $30,000 a year or $2,500 a month to get there.
Many people get “sticker shock” when they first see how much money they’ll have to save per month or per year to meet their retirement goals. The numbers can certainly seem daunting, especially if you’ve been putting off saving for retirement. However, remember that retirement savings plans deliver excellent interest rates and tax benefits that protect your money and help it grow quickly.
To that end, we recommend using a retirement savings calculator to guide your financial planning. These online tools take a myriad of influential factors into account, including interest rates, inflation, your salary, and your expected salary increases over time. Plug in the numbers and chances are you’ll find the figures a little more manageable than they seemed when you did raw, basic calculations.
When you start saving early, you’ll need to contribute less money per month or year to reach your retirement goals. If that ship has already sailed, consider these strategies to accelerate the value of your retirement portfolio:
Take advantage of employer offers. Many employers offer to mirror or match any contributions you make to your retirement plan. If such an offer is available to you, jump at it as you’ll find it far easier to reach your savings goals. Many personal finance experts even rank saving for retirement ahead of paying down debt if employer match offers are at play.
Avoid taking risks to make up for lost time. If you’ve waited until later in life to start saving for retirement, don’t be tempted to make risky investments. Sure, the prospect of a major windfall might be alluring, but you could wipe yourself out if things don’t go your way. Slow and steady wins the race when it comes to retirement savings.
Consider real estate as a powerful retirement investment. If you’re looking beyond institution-based retirement savings plans for investment ideas, consider real estate. Purchase an investment property, have renters pay down your mortgage over time, and you’ll likely own the property free and clear by the time you retire. Then, the rental income becomes money in your pocket.
You can find other ideas and investment opportunities that match your financial situation and risk profile by speaking to a licensed financial adviser.
Try not to panic about your retirement, even if you haven’t started saving at all. There are many things you can do post-retirement to help make ends meet. Assuming you’ve built up a solid amount of equity in your home, you can take advantage of refinancing programs for retirees. You can also downsize to a smaller home that’s also easier to maintain. Holding a part-time job is also highly beneficial for older people, as it keeps retirees socially active, which has many physical and mental health benefits.
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Jim Greene is a freelance writer based in the Toronto, Canada area. He has been writing professionally since 2001 and has an extensive professional background in consumer research, personal finance and economics.
