It’s not hard to understand that retirement savings need to be relatively large in order to live sustainably and achieve each goal you have set out for yourself once in retirement, but understanding exactly how much is a little bit harder to conceptualize. Understanding how much you’ll need to comfortably retire takes a fair amount of foresight and planning so as not to reach the point of retirement just to realize you need to keep working a part-time job in order to achieve those goals you have set out for yourself towards the end of your life. This article goes into more specific detail on points of consideration for individuals wondering just how much they need to have saved in order to retire comfortably at the age of 65.
Understanding What Constitutes “Living Comfortably”
There are a number of general “rules of thumb” that experts and financial advisors utilize to determine how much an individual needs to save to live a comfortable retirement. Some advisors consider $1-1.5 Million to be more than enough for individuals to retire with. Some advisors take a more formulaic approach, suggesting that individuals will need to save between 10-12 times their current annual income to stay comfortable in retirement. Still, others suggest saving enough to have 70-80% of your pre-retirement income as income in retirement. Still, this leaves out many of the additional costs associated with extra items that aren’t included in the expenses of living life, such as trips and purchases you’ve been saving for many years for.
Calculating Monthly Expenses
While each individual has different understandings of what it means to live comfortably, ultimately understanding how much you’ll have needed to have saved by the time you reach retirement will depend on the type of lifestyle you hope to live once you retire. This can be easily calculated by breaking down your average monthly costs, which can be multiplied by 12 to give you an estimate of your average expenses in a year, which can be further multiplied by the number of years you expect and hope to spend in retirement before reaching the end of your life. The average American lifespan is just about 79 years, so we’ll assume, for our purposes, that an individual retiring at the age of 65 will need to save enough money to last 14 years.
Calculating average monthly expenses should be comprehensive, leaving no stone unturned. While it may not seem like a big deal to leave out small ‘in the moment’ costs such as gasoline for transportation, when we extend theses costs to 12 months for 14 years, these minute costs can quickly accumulate to large sums of money that you’ll be happy that you’ve accounted for, rather than finding out you budgeted several thousand dollars too little. Your monthly expenses should include costs such as housing (mortgage payments, rent, taxes, utilities), food, transportation costs, health care (especially as you age), personal insurance, personal care, family care, and other miscellaneous costs including entertainment, hobbies, and charitable contributions. It isn’t until we sit back and think about the many costs we incur on a monthly basis that we understand why so much money is needed to enter retirement and continue to live a comfortable lifestyle.
Calculating Your Comprehensive Costs
After you have an understanding of your monthly or yearly expenses, you’ll be able to calculate exactly how much you’ll need in retirement for everyday expenses. It’s typically a good idea to overcompensate some of these figures in order to accommodate the effects of inflation over time that will inevitably increase the cost of everyday items, in addition to other unexpected costs that may come up such as healthcare costs. According to the Bureau of Labor Statistics, the average household aged 65+ spends roughly $3,800 a month, which is about $1,000 less than the average of all US households combined. $3,800 a month calculated out, comes out to be $45,600 a year. For an individual retiring at the age of 65 and enjoying a 14-year retirement, this amount comes out to be $638,400.
$638,400 is by no means how much you should aim to have saved by the time you reach retirement, however. Depending on the age you retire at, the amount you plan to spend each year in retirement, and the number of years you expect to live will greatly fluctuate this number. For example, an individual with a higher than average pre-retirement income looking to receive $100,000 in yearly income in retirement hoping to live until the age of 90 will need to have saved $2,5000,000 by the time they reach retirement. An individual estimating a lifespan of 90 years with $65,000 a year in retirement income will need to have saved $1,600,000 in taxable investments.
Other Expenses to Consider
In addition to everyday expenses, you’ll also want to factor in the large costs for specific trips or purchases that extend outside the realm of general everyday expenses. This is critical since it could be detrimental to your budget in other areas if you don’t plan for a car purchase or home purchase that could dig into expenses in other areas. You’ll also want to consider whether or not it’s important to you to leave behind a sum of money for a spouse or children once you pass away. No matter what your larger expenses will be in retirement or whether or not you’re hoping to leave behind an inheritance, these should be added to your end amount in order to properly save.
Saving To Meet Your Goals
Once you’ve calculated how much money you expect to need in retirement and estimated how long you plan to live, you’re set to put a savings plan in place that outlines how much you need to save each year to retire without the need to turn around and join the workforce again several years into retirement. Retirement income will come from a variety of sources including retirement savings accounts such as 401(k)s, IRAs, and Roths, in addition to income supplied by retirement benefit sources such as Social Security or defined benefit pension plans. You’ll want to subtract the amount that you currently have saved and expect to receive in retirement (from Social Security or Pension plans) from the total amount that you’ll need in retirement. The leftover amount will be the total you need to save by the time you reach the desired point of retirement.
Tax Implication for Retirement Savings Accounts
Whether you have a 401(k), IRA, or other forms of savings account, all are great sources for retirement savings. That being said, depending on the type of account, there are different tax implications that could greatly fluctuate the amount of money that you actually have in your account versus the amount you’ll be able to collect in retirement.
Traditional and Roth ‘versions’ of both 401(k)s and IRAs differ depending on the point at which the money in the account is taxed. Roth 401(k)s and Roth IRAs are both taxed when the money enters the account. This means that the money is free to grow tax-free, and what you see in the account is what you get in retirement. Roth accounts are best suited for individuals early on in their career who expect their tax bracket to be higher when they reach the point of retirement as opposed to what they are being taxed in the present. Traditional accounts on the other hand, are taxed when the money is withdrawn from the account in retirement. Therefore, the money that’s in the account is not necessarily what you’ll have in retirement, so individuals with this type of account should be careful to calculate this component of their savings so as to avoid significant roadblocks in their budgeting. Traditional accounts are best suited for individuals that are currently in the high income-earning point of their life since their tax bracket will likely be lower in retirement than it is in the present.
Both types of accounts have additional age requirements, contribution limits, and required minimum distributions that should be heeded in order to ensure you have enough money in retirement to live comfortably. Individuals are unable to withdraw from 401(k)s or IRAs before the age of 59.5 without tax penalties that can needlessly drive down the value of your savings. Additionally, required minimum distributions must be taken from these accounts typically when individuals reach the age of 70.5, after which point there are significant tax consequences that could greatly decrease the value of your savings accounts. With Roth accounts, you’ll also want to be sure that you have the account open for at least 5 years in order to avoid tax consequences for withdrawing from the account too early.
Contribution limits on respective accounts are also important to note, considering that depending on when you begin your retirement saving processes, you’ll only be able to contribute so much to certain accounts on an annual basis. This could mean that you may not be able to contribute as much to your savings accounts as you may need to live comfortably in retirement, hence, the importance of starting the retirement savings processes as early as possible. With 401(k) accounts, individuals under the age of 50 are able to contribute a maximum of $19,500 a year, while those over the age of 50 are able to contribute up to $26,000 a year. For IRA accounts, individuals under the age of 50 are able to contribute up to $6,000 a year, while those over the age of 70 are able to contribute up to $7,000 a year.
While you are able to open as many accounts as you’d like, contribution limits are calculated across accounts, which can lead to difficulty in tracking your account, and doesn’t necessarily bring you advantages. For high-income earners or individuals looking to invest more money than tax-advantaged retirement savings accounts will allow, there is the added option to open a taxable investment account. While the investments in the account are taxed, it allows for you to invest and store much more money than you would with other retirement plan options, and allows you to realize larger returns on your money than you would if you were to simply keep your money in a savings account.
Timing Your Social Security
The Social Security system, established to provide benefits to retired, disabled, and survivor Americans, is funded by American payroll taxes. For every $1,410 received in earnings, American workers are eligible to receive one “credit.” Workers are able to gain as many as 4 credits in a year and must accumulate 40 credits overall to qualify to receive retirement benefits from the Social Security Administration. This comes out to be 10 years of work to qualify to receive benefits in retirement. The amount that you receive in Social Security benefit on a monthly basis is calculated by assessing the inflation-adjusted average of your top 35 highest-earning years of work. Individuals hoping to receive benefits from Social Security should be sure that they qualify by working enough qualifying years.
Additionally, the time at which you choose to begin receiving your benefits could impact how much benefit you receive from Social Security. Qualifying workers are able to begin receiving Social Security benefits at the age of 62, however, there is an added benefit to waiting until your “full retirement age” (dependent on your year of birth), in addition to waiting until the age of 70. Individuals who don’t wait to receive benefits until their full retirement age after they reach the age of 62 have the potential to lose as much as 30% of their monthly benefit.
On the other hand, if you wait until after you reach your full retirement age to begin receiving benefits, you will receive an additional 8% for every year you wait until you reach the age of 70, at which point there is no added benefit to delaying receiving your benefit. Having a better understanding of when and how you should time receiving your Social Security benefits can have a pretty significant impact on the amount of benefit you receive, and more money in retirement never hurt the level of comfortability with which people live.
Saving To Cover Your Complete Expenses in Retirement
You’ll want to do everything in your power to ensure that when the time comes for you to retire, you are able to do and achieve all that you’ve set out for yourself while doing so comfortably. Working with a financial advisor is a great way to ensure that all your bases are covered, considering they can work with you and your current financial situation to work out a financial plan that will allow you to live the retirement you envision for yourself. Contact your advisor today to see how they can help you to feel comfortable knowing when it comes time for you to leave the workforce, you’ll be able to do so with dignity, financial stability, and excitement for the many years of enjoyment ahead.