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How Much Will I Need To Save For Retirement?

December 11, 2006 – by Richard Band

Everyone contemplating retirement must face this question sooner or later: How much wealth must I accumulate on my own, over and above Social Security and any corporate pension benefits to which I may be entitled?

The answer begins with another question: What lifestyle do you desire for yourself in retirement? Most research I’ve seen suggests that a typical married couple can retire comfortably on 70% of their pre-retirement income. (With singles, it’s more like 65%.) But you must decide whether that figure makes sense for you.

Estimate Your Expenses

Take a few minutes to estimate your current annual household expenses (in today’s dollars). Adjust these expenses to allow for the changes that will occur when you retire: presumably no more mortgage payments, no more life insurance or disability premiums, no more commuting expenses, possibly lower property taxes, perhaps one car instead of two.

Try to think of all the things you won’t be doing in retirement. Now add back into your budget an allowance for all the things you would like to do when you retire: play more golf, travel more, eat out more, etc. Be sure to include a contingency factor for unpleasant surprises like extended illness.

You may find that you can get by quite nicely on less than 70% of your working income. In fact, most families earning more than $70,000 a year can.

Add Up Your Investments

After you’ve projected your retirement budget, figure out the value of your investment portfolio. (Don’t include your home, unless you plan to sell it when you retire.) The amount of wealth you’ve already socked away will make a tremendous difference in determining how much you need to save between now and retirement.

Many people, having never toted up their investments, don’t know how wealthy they really are. When I computed my net worth for the first time (about a decade ago), I was astonished at how well my investment program had done. Now I check the numbers about once a year. You should, too. You might be in better shape than you think!

Three Hunches About the Future

Estimating your household budget and adding up your investments are pretty much cut-and-dry chores. Now comes the part where you have to make some guesses — or “assumptions,” as the boys with the green eye shades would say.

How big a retirement nest egg you’ll need depends on three more factors:

  • Your remaining lifespan
  • The future rate of inflation
  • The yield you’ll earn on your investments

It is possible to make an educated guess about these items. Actuaries saw, for example, that a person age 65 can expect to live another 20 years (men about a year less, women about a year more). You want to make sure your retirement income lasts as long as you do at least!

For a table of life expectancies, get a copy of IRS Publication 590 (available online here), but remember, actuarial tables only reflect average experience. You know your own health and your family’s health history. Are the standard numbers too high, too low or about right? It’s a judgment call.

Inflation and Yields

If you think it’s hard to gauge your remaining lifespan, try projecting the inflation rate or the yield on your investments! Fortunately, the real rate of return (after inflation) on your portfolio is far more important for our purposes than either inflation alone or yield alone — the real return tends to be fairly stable.

I’m assuming a 4% real return, composed of an 8% yield on your portfolio minus 4% inflation — you would be earning this return inside a retirement account, deferred annuity or other tax-sheltered vehicle. The result won’t change much if inflation turns out to be 5% or 3%, as long as your portfolio continues to net 4% more.

Why not use a higher real return in your planning? A person in his 30s or 40s might. By investing a sizable chunk of your wealth in common stocks, you might be able to boost your overall portfolio return to 9%, 10% or even higher — before inflation. Net of inflation, you should be able to pull down a real return of 6% to 7% with growth stocks or growth-type mutual funds.

Indeed, I recommend such an approach, but if you’ve got 10 years or less to retirement, you should plan conservatively. There’s not much time left to repair mistakes.