Many people do not think about the answer to this question until it is too late. In fact, a recent study by the American Savings Education Council found that only 42% of workers had estimated the amount they would need to live comfortably in retirement. Of course, the correct answer will depend on the individual and their desired post-retirement lifestyle.
People who do not have an accurate measure of their future financial needs will often work longer than they need to or retire too early and run out of savings. Not having an accurate goal for retirement income can also lead to choosing the wrong type of investment vehicle. While there is no set amount that will be right for everyone, there are several steps that can be taken to come up with an accurate estimate.
Start off by estimating the amount of income you will need in retirement. Seventy-five to eighty-five percent of pre-retirement income is a good starting point. Remember to include any pension payments you may be entitled to. Depending on your age, Social Security may also be a factor (it is far less of a sure thing for younger workers than those close to retirement). Also, don't forget to adjust your income figures for taxes or you will end up far short of your goal.
Those planning to retire early (between the ages of 55 and 65 presents) will face different financial challenges, as they are likely to still be in good health and be very active in the early stages of their retirement. Many early retirees take advantage of their newfound freedom by traveling or purchasing cars, vacation homes, boats, etc. Often times, there will be a reallocation of capital assets to offset these additional purchases. For example, downsizing the family home once the kids are gone may provide the funding for a new recreational vehicle.
Once you are satisfied with your income estimate, you need to convert that income figure to a total amount needed at retirement. A good rule of thumb is to estimate an annual withdrawal rate of 4-5%. For example, if you will need $75,000 per year in retirement with a 4% withdrawal rate, you will need a total of $1,875,000 in your retirement savings account to draw from.
Now that you know how much you will need to save, it's time to figure out how to get there. The math involved in calculating the future value of investments is beyond the scope of this article, but there are many online retirement planners that can perform the calculations for you. Before committing to any investment plan, it is also a good idea to run through your calculations again with a professional financial planner. Paying a small fee now can save you costly mistakes down the road.
Once you have established your initial plan for retirement savings, review it periodically to make sure you're still on track to meet your goals. The pre-retirement accumulation period can span many years, even decades. During this time, changes in financial circumstances, marital status, and number and age of children can drastically affect your retirement calculations.
Having a plan for your early in your career will help you live a comfortable life in your golden years. Many people neglect this area of their financial planning and work longer than they must or retire without adequate savings. By the time retirement comes around, it is far too late to correct any errors in planning and the individual's post-retirement lifestyle will be diminished.
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