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When it comes to knowing how much to save for retirement, the only thing experts agree on is that the amount of money needed is different for every person. An old rule of thumb suggested a $1 million nest egg was the goal for retiring in comfort, but the reality is much more complicated.
The real method for determining how much money you'll need set aside to live on when you retire is based on how much you are earning prior to retirement, how long you expect to live and the lifestyle you plan on pursuing in retirement.
The 80% rule
AARP endorses what many financial advisors now recommend as the new rule of thumb. They say, "You'll need about 80% of your pre-retirement income when you leave your job, although that rule requires a pretty flexible thumb." For example, someone making $100,000 before retirement could plan to live off $80,000 a year after retirement.
Kevin Michels, a Certified Financial Planner™, and the owner of Utah-based Medicus Wealth Planning explained that while some expenses will decrease in retirement, others expenses typically increase. "The biggest decrease in expenses usually comes from taxes and savings. For one, you won't be paying into Social Security and Medicare through payroll taxes or depositing money into a 401(k), Roth IRA or other savings plan each paycheck."
You'll also save on work-related expenses like gas for your commute, eating out at lunchtime or buying new clothing and paying dry cleaning bills. Some people also make it a goal to pay off their home before retirement, which means they won't have a mortgage to keep up with. Retirees tend to no longer have dependents, as well, which means they only have to support themselves or themselves and a spouse through their golden years.
In practice, however, you may find you have new expenses, like investing money in that hobby you finally have time for, renovating your home to make it easier to age in place, traveling more often to see family or going on more vacations. As you age, you may also find yourself facing more medical expenses like deductibles for hospital visits, co-pays and prescription drugs. Because of the margin of error, it is better to overestimate what you think you might need rather than low-ball it.
"Most people underestimate what they'll spend in retirement. While they will be paying less in taxes, and no longer saving, those expenses are often replaced with more vacations, hobbies, and medical expenses. It's important to be honest with yourself and not plan a retirement on a shoestring budget", Michels said.
Estimating life expectancy
The next thing you'll need to take into account is life expectancy. The Social Security Association (SSA) has created a Life Expectancy Calculator to help you determine how many retirement years you should budget for. By entering your gender and birth date you can see how many more years someone your age today can expect to live and how many additional years you can expect to live at ages 62, 67 (full retirement age) and 70.
According to the SSA, these estimates are based on average reported life spans and "do not take into account a wide number of factors such as current health, lifestyle and family history that could increase or decrease life expectancy."
Based on these estimates, the average American can plan on living at least 20 years in retirement. In the previously mentioned example of someone planning on living off $80,000 a year, he or she would need at least $1.6 million saved up to last 20 years.
Luckily, most people will not have to come up with the entire amount they'll need to live on through retirement. In addition to their 401(k) with an employer match and other savings, workers who contributed to pensions can expect a monthly stipend at retirement and Americans who work and contribute to Social Security can begin drawing those funds at about age 66 (depending on your birth year) for a full benefit. By creating an account with the SSA, you can see how much you would currently qualify to withdraw once you reach retirement age and how that amount would be impacted by choosing to apply for it early (as early as age 62) or delaying until as late as age 70 when the maximum monthly benefit would be reached.
"The decision on when to take your Social Security benefit is based on a lot of factors, but most important of all is your life expectancy", Michels said. "If you're healthy and have a history of longevity in your family, it's typically best to wait as long as you can up to age 70 to take your Social Security benefit."
Planning your retirement: A case study
Michels, who specializes in helping people prepare for and transition into retirement, presented a case study of a married couple thinking of retiring.
Based on their health and family history, the 62-year-old couple could reasonably count on living as long as 30 years in retirement. They have $1 million in investments between their 401(k), Roth IRAs, and brokerage accounts and a rental property that cash flows $12,000 per year. With a desire to spend $100,000 in retirement they're wondering at what point they could retire.
After careful planning, Kevin recommended they work two years longer, max out their 401(k)s and retire at 64. In retirement, Michels recommended they wait until their full retirement age to draw Social Security benefits, perform Roth conversions to reduce taxes down the road, and primarily fund spending from their brokerage account to reduce taxes now. In addition, Michels made recommendations on how to qualify for tax credits to pay for private insurance before Medicare age, and how to give to charities in the most tax-efficient manner.
The end result was clarity that they could retire comfortably and with confidence that they wouldn't ever run out of money.
Preparing for retirement is a marathon, not a sprint. When it comes to financial planning and investment management, it's important to work with an advisor you can trust. If you are retired or plan on retiring within the next 10 years, contact Medicus Wealth Planning today to see how they can help you manage your wealth and maximize your comfort during your retirement years.
