How much do you need to retire? And, equally important, how do you reach that goal? These questions baffle many American savers, and it’s no wonder. Financial experts throw out retirement savings numbers ranging from $1 million to $5 million, along with confusing rules about how much you should save, what your retirement living expenses will look like, and how much you can withdraw from your portfolio each year.
Let’s try to clear up that confusion right now with real-life numbers. The table below shows estimated retirement income, savings targets, and required monthly contributions for different salary levels and time frames. As is the case with any retirement projection, these numbers carry several assumptions, which are explained below the table. Review those explanations carefully; they can help you construct retirement projections tailored to your situation.
| Salary | Estimated Income Needed from Savings (70%) | Savings Target | Monthly Contribution With 20 Years to Reach Target(% of Salary) | Monthly Contribution With 25 Years to Reach Target(% of Salary) | Monthly Contribution With 30 Years to Reach Target(% of Salary) |
|---|---|---|---|---|---|
| $50,000 | $35,000 | $777,778 | $1,480 (36%) | $955 (23%) | $635 (15%) |
| $60,000 | $42,000 | $933,333 | $1,785 (36%) | $1,145 (23%) | $765 (15%) |
| $75,000 | $52,500 | $1,166,667 | $2,230 (36%) | $1,435 (23%) | $955 (15%) |
| $100,000 | $70,000 | $1,555,556 | $2,970 (36%) | $1,910 (23%) | $1,270 (15%) |
| $110,000 | $77,000 | $1,711,111 | $3,270 (36%) | $2,100 (23%) | $1,395 (15%) |
| $125,000 | $87,500 | $1,944,444 | $3,715 (36%) | $2,395 (23%) | $1,585 (15%) |
Estimated income needed from savings
How much income you’ll need to generate from your retirement savings depends on your living expenses in retirement. An old guideline advises you to plan on needing 70% to 80% of your working income to cover your expenses in retirement.
But that’s overly optimistic today, particularly if you retire with a mortgage, credit card debt, or student loans. Some expenses will go away, like retirement contributions, but others will increase. The big wild-card expense in retirement is healthcare. One study from the Center for Retirement Research at Boston College estimates that the average retiree will spend $4,300 annually in out-of-pocket medical expenses, not including long-term care.
So it’s wise to assume you’ll need 100% of your working income in retirement. Social Security typically replaces 30% to 40% of that, depending on when you claim. The chart above assumes 30%, which means your savings will fund the remaining 70%.
Savings target and the 4.5% rule
Once you know how much income you need from your savings, you can do a quick calculation to translate that into a target savings balance. Simply divide your income number by 4.5%, or 0.045. If you need your savings to generate $70,000 in annual retirement income, for example, you’d aim to amass at least $1,555,556 in your retirement account.
This calculation is based on the idea that you can safely withdraw 4.5% of your retirement savings in your first year of retirement. Thereafter, you can adjust your distribution to keep pace with inflation. At that withdrawal rate, a portfolio of 50% in stocks and 50% in bonds should remain solvent for 30 years, even through bear markets that rival history’s most volatile times.
Average annual return, inflation, and taxes
Now for the fun part, which is understanding how to reach your target savings balance. You can use any compound earnings calculator online to play with these numbers on your own. You will need to assume an average annual growth rate. The chart above assumes a 7% growth rate, which is in line with the long-term annual average of the stock market. You could use a lower rate to be conservative, but not higher. Even professional mutual fund managers don’t beat the market consistently.
Inflation is another consideration when you’re projecting long-term earnings growth. Inflation in recent years has been about 2% annually. To keep things simple, the retirement data above assumes no inflation, but also no salary increases. In real life, your income should rise each year, and at least keep pace with inflation. Know that if you want to project these numbers on your own and you account for future salary increases, you’d have to account for inflation, too.
Year-to-year taxes can slow your wealth production, which is one argument for investing in a tax-advantaged 401(k) or IRA. In those accounts, you don’t pay taxes on your earnings until you withdraw funds in retirement. Again, for simplicity’s sake, the chart assumes you are investing in a tax-advantaged account and have no annual taxes (though the highest contribution amounts above do exceed the federal limits). In 2020, you can contribute up to $19,500 in your 401(k) and $6,000 in your IRA. For savers 50 or older, contribution limits increase to $26,000 for the 401(k) and $7,000 for the IRA.
The takeaways
The big standout in this retirement chart is the contribution rate, and how it changes based on your savings timeline. If you have 20 years until retirement and no savings, your target contribution rate is 36% of your pay. That’s likely unrealistic. The next best thing is to contribute whatever your budget allows now, and raise that contribution with every salary increase. Plan on putting any cash windfalls into your IRA or long-term savings account, too.
A second big takeaway is the size of the saving balance you’ll need. Social Security will keep you out of poverty, but it will not fund the lifestyle you’re used to. To avoid a big lifestyle downgrade, most people need seven figures in the bank at retirement. You can only reach that goal by taking your retirement savings seriously. Either you make tough choices now to save and invest, or you spend your senior years just scraping by.
Finally, you have to invest in the stock market to reach your savings goals. These projections use a 7% growth rate, which is seven times higher than what you’d earn in a high-yield savings account. Stocks come with a risk of loss, but staying out of the market guarantees you’ll have to downsize once you stop working.
