How to Tell if You're on Track for Retirement
It may be a little bit early to think about retirement all too seriously if you still have several decades left before you face it. But don't look now -- time flies and before you know it, there won't be much time to prepare for retirement. On this subject, the big question I have in mind is this: how do we know if we've saved enough for our retirement years?
In order to maintain the lifestyle that we are used to, the conventional wisdom tells us that we need to be subsisting on an income equivalent to 75% to 90% of what we currently make prior to retirement. This is a natural assumption because we don't expect to have the same amount of expenses in our older age as we do when we are growing our families. Of course, it would be another story altogether if you expect to live it up in a big way once you've retired.
While retirement is a long time goal, it would still serve us well to plan for it while we're still young and healthy. I've been saving for retirement ever since I started earning an income because I realize that with long term investing, time is of the essence. As the saying goes "Timing the market is not what's important. It's time IN the market." Simply put, investing early and as regularly as you can makes a huge difference in how large your nest egg will be in your old age.
So let's answer the question: how much savings do we need to retire? Here are a couple of ways to calculate the answer:
Solution 1: Use online retirement planners and calculators.
You'll find these free tools available in a variety of sites, such as standalone investment sites, mutual fund sites such as T.Rowe Price and Vanguard, or even at discount brokers (the likes of which I've reviewed: you can check out my reviews of Scottrade and TradeKing). They offer great ways to help you plan for retirement which are based on several assumptions such as:
- Your current age
- The age you intend to retire
- How long you expect to live
- Your current income
- Your cash flow during retirement
- The size of your retirement savings
- How much you expect to contribute to savings
- Expenditures during retirement
- Risk level of your investment portfolio
- Historical return rates of your portfolio
I would suggest trying out these calculators to give yourself some idea of where you stand with regards to your retirement savings. For my retirement planning, I've visited Scottrade to try out their tools. These tools can help us figure out the cost of waiting (which tells us what happens to our accumulated savings based on when we start investing), how much to save and how long our retirement savings can last, and how to choose between a traditional IRA and a Roth IRA. Knowing these facts is a great way to start developing your retirement plan -- and as you can see, it's easy enough to do on your own.
Solution 2: Try a quick and easy retirement savings formula.
I would also suggest using the following simple formula for determining exactly how much it is you should have saved by the time you retire. Just crank out your numbers manually as follows:
1. Know how much income you'd like to have during retirement.
2. Peg down an annual withdrawal rate that you're comfortable with. How much of your retirement savings do you plan to withdraw each year? In order to keep your nest egg intact, the recommendation is for you to withdraw between 4% to 6% of your savings on an annual basis.
3. Make these calculations.
To find out how much savings you need to support yourself during your retirement, try this formula:
Your annual income during retirement divided by the annual withdrawal rate should equal your desired savings.
As an example, let's say you are making $80,000 a year right now. If you expect to live on 80% of your current income during your retirement, then designate this to be $64,000. If you determine your withdrawal rate to be 4%, then your nest egg by the time you retire should be:
$64,000 / .04 = $1,600,00
Take note that the result here is but a rough estimate. Of course, if you plan to work through retirement, then such a savings amount should be adjusted accordingly. The formula is simplistic but it helps give you a basic idea of what you need to do.
One of the best ways to save up for your later years is to maximize your contributions to tax-advantaged retirement accounts. Better yet, contribute the maximum to your retirement plans and take advantage of employer contributions to your program as well. All this is pretty well known advice that seems simple enough to do, but surprisingly, a lot of people tend to procrastinate on this matter. Remember that the better prepared you are, the more likely you'll be able to enjoy your golden years without financial worry.