There are lots of thumb rules for this one, but let’s stick with the basics. Financial planners suggest retirees plan to spend at 75% of their expense rate during their working years. This income is generally assumed to come from a number of sources, including social security, 401(k)/IRA balances, Health Savings Accounts, pensions, and other savings amounts.
As an example, if you are making $60,000 a year, the average wage of the American family, you should plan on requiring $45,000 a year to maintain your standard of living. The thumb rule really requires one to look at expenses, so let’s assume after taxes a family making $60,000 a year is really depositing $48,000 a year, or $4,000 a month. Applying the thumb rule, one would assume $3,000 a month is required in retirement in order to maintain your current standard of living.
In order to “discover” where this $3,000 per month will come from, start first with your social security benefits. The IRS has a nifty calculator posted here. Depending on how long you have worked, how much you have contributed and at what age you plan to retire, the social security benefit could range from hundreds of dollars per month up to more than $3,000 per month. A note of caution – for this example a family who had been making $60,000 per year likely did not contribute up to the max amount, and therefore the $3,000 per month is not available. In any event, the Social Security estimator should be your go-to resource on this topic.
Let’s assume an individual retires at 62 and the benefit is reduced (full retirement age is 67 for individual born in 1960 or later) to an amount of $1,300 per month. In this instance the expense “hole” to fill is $1,700. Now one needs to look at those other sources of income. The second thumb rule we will apply here is the 4% rule, which says you can withdraw 4% of your balance each year and not run out of money in retirement. There is lots of debate as to the efficacy of this rule given the zero interest rate environment over the last five years (Google “Bernake and Quantitative Easing” for a more in depth explanation), but let’s apply it here then quality at the end.
Because we still need to find $1,700 a month, we need approximately $20,000 a year from our personal balances. To solve for the balance that is needed to make $20,000 a year 4% of that total, divide $20,000 by 4% and you end up with $500,000.
So the answer in this example, an individual or family grossing $60,000 per year and looking to maintain their standard of living with that Social Security benefit (remember, the longer you wait to draw, the more Social Security pays) would need roughly $500,000 in savings. Again, these savings can be in a 401k, IRA, Health Savings Account or non-tax deferred accounts. The where is not necessarily as important as the what.
Everyone’s situation is different, but the magnitude of this number underscores why the mantra is “save more.” The good news is this balance is not unachievable over a lifetime of working. Stories abound of families who have consistently saved $3,000 or $5,000 a year for 30 years and ended up with a $800,000 or $1,800,000 balance at retirement. Make the magic of compound interest work for you by consistently saving and you should be all set.