It seems like such a daunting task. The mountain climb to the summit of retirement is quite the hike with many obstacles that 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 close to 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 once per year 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 you can calculate 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 what your living expenses will be 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 the next step.
List out your current living expenses, starting with your fixed expenses.
This group will include:
Next, list your variable expenses:
- Groceries
- Utilities
- Internet, cable, and phone expenses
- Entertainment
- 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 will have to 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 currently have a family, and your kids will be grown and gone by retirement.
- Repairs and Maintenance: You might make an adjustment 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, and that will almost certainly be more costly than the plan you have now.
- Employer Subsidies Vanish. Many employers offer very generous health insurance premium subsidies; the cost of Medicare plus a Medicare supplement could be more expensive than the current contribution you make to your plan.
- Need for Better Coverage Due to Age or Health. In general, the need for health insurance increases with age; you may need more comprehensive coverage than what 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 only recently finished absorbing the massive changes that came about from Obamacare, but there’s no guarantee there won’t be more costly changes later.
I’m not trying to scare you with regard to health insurance considerations in retirement. But, it is a major “X” factor, and one that will require special provision.
Once you have made adjustments 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 trying something like goal or other stable materials and goods.
If you only calculate inflation until you retire you may run into some cash flow issues once you start withdrawing your funds. This is particularly important for those who are trying to retire super early, including those in their 30’s and 40’s.
It is better to aim too high and end up just fine in retirement than to aim too low and be running 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 individual portfolio segments will return, you should know what…