“How much should I save for retirement?” It might be one of the most common questions we get here at Summit -- and rightfully so.
It’s a big question. This is why, when you ask 10 financial advisors, you’ll receive 10 very different answers. That’s not to say any of those 10 advisors are wrong, it’s that there are many different facets to this question. You see, it is possible to define a specific account value to aim for (and that’s the purpose of this post), but to determine that number we need to account for, assume, and even make some educated guesses about the future. But let’s not get ahead of ourselves.
1) Rethink the “How do you envision your retirement?” question
I’ve never liked this question advisors often ask their clients. I'm 33. I can't imagine what next year will look like, let alone retirement. How am I supposed to know what might life will look like, what my passions will be, or even what the state of our economy or world will be in?
But I understand why advisors ask the question.
In order to get from A to Z, one needs to know what Z might look like in order to start on a path toward it. Yet, the problem here is, many people do not really know what they want it to look like, or perhaps they don’t really know what is possible within the context of their income and saving capacity.
People are naturally gifted at weighing sacrifice / reward. That’s something that is learned from our early childhood years. I have two young girls — age 2 and 5. It’s amazing how my 2-year-old already understands conditional statements. She understands that if she takes a toy from another child, she will receive a timeout. It took a while for her to comprehend that. As parents, our jobs became a lot easier once she did. Now she weighs sacrifice / reward in a very simplistic way. If she eats all her carrots, she gets to go to the park. With the five-year-old it’s even easier. If she picks up the clothes in her room, she gets a popsicle.
As adults, we are much more advanced at this, but our lives are made up of making choices between sacrifice and reward.
How does this relate to planning for retirement?
Oftentimes financial advisors will lead with the question of “how do you envision retirement”. That can lead to a road block because we are being asked to come up with the “reward” without fully understanding the “sacrifice” it will take to reach that.
Therefore, I would suggest the first question to ask in your retirement planning journey is not: “how do I envision retirement”, but instead it should be: “How can I know what is a realistic and achievable dream retirement for me?” Because from there, we can then use our natural sacrifice / reward instincts to set a dream retirement for ourselves, and adjust as necessary.
2) Start with math
A place we often like to start is by running an equation, starting with your current lifestyle.
Our current lifestyle can be a good point of reference. We might have an idea that in retirement we want to travel, or fund our grandchildren’s education, or buy a lake house. All of those are worthwhile goals, but first let’s start with something we are comfortable with; our current lifestyle, then adjust from there.
It is pretty standard in retirement planning to start the equation with calculating 75% of your current income. Retired couples who desire to live a similar lifestyle in retirement as their working years can often do so on 75% of their working year income. The reason is because you have less expenses. You aren’t raising children, you don’t have work related expenses like commuting. You also have a lot more time on your hands which many use to work part time or start a small business which will generate some income.
3) Target the percentage of income you need to set aside, not the dollar amount
Here’s a great calculator that can help with that.
What you want to do is plug in all of your numbers, then look not at the final number it kicks out, but at the percentage of income you need to be setting aside right now in order to reach your number. That number is adjusted for inflation. This is especially important if you are younger. The more you can get used to targeting a certain percentage of your income to save, rather than a dollar amount, the better off you will be when approaching retirement.
The reason is because as your income changes, your lifestyle changes. We want your lifestyle to be similar to what it is when you retire, not what it was in your 20s or 30s because, well, things change.
4) If you are in your 20s / 30s, don’t count on Social Security
While this program MAY be around when you retire, it may not be. Some believe Social Security could go bankrupt as early as 2034, while other experts believe the government will make adjustments to keep it around. The bottom line is no one knows what will happen, so it is best not to count on it.
5) Have a good blend of pre-tax and after-tax retirement accounts
Roth IRAs are made up of after-tax dollars. What this means is that while you’ll fund that account with your net income, you will also not be required to pay taxes on the distributions in retirement. This is very advantageous to you. Traditional IRAs and 401(k)s are also beneficial in that you can contribute to them to bring down your taxable income now, and some 401(k)s may come with an employer match. Take advantage of this as well, especially while your income tax bracket might be higher right now during your working years than it will be in retirement.
6) Use non-retirement accounts to fund specific dreams you might have
It is time to separate your dreams from your retirement lifestyle. You have to distinguish between funding specific goals you have from the way you want to live your everyday life. For example, if you plan on taking a few trips overseas, or perhaps you want to purchase a second home, or buy a boat, or fund your grandchildren’s education, this should be a separate savings goal.
The reason is because these will not be ongoing budgetary monthly expenses. They are one-time purchases or investments. These can be funded through separate savings accounts, perhaps equity you built in a home, or a non-tax sheltered investment account.
A tip here would be to — again — go back to the retirement savings calculator. Be sure you are on track for the desired lifestyle. Then begin to fund your specific savings goals outside of that.
7) Understand how inflation impacts your goals
This is where retirement calculators such as the one we linked to above can come in really handy. $100,000 of annual income may be plenty for you to achieve your desired lifestyle now, but as inflation increases, your purchasing power decreases. That means you need to run the numbers with this in mind.
I hope I’ve given you enough to think about while still honing in on a specific answer for your situation. The bottom line is, there is no one answer when it comes to “How much should I save for retirement” because there are so many factors to consider. However, using the tips and tools provided, you can begin your journey to coming to a ballpark number. It should start with setting the right expectations. From there, you can better understand what sacrifices you may need to make in order to fund a more or less expensive retirement, which in turn allows you to make more or less sacrifices now.
We wish you the best on your journey, and we are more than willing to assist. Just give us a call, we are here to help.