How much money do you need to save to live comfortably in retirement? Some experts base estimates on a multiple of your current salary or income, while others focus on a flat amount such as a million dollars. Either way, the task can be daunting.
But there is no magic formula and every situation is different. What's more, your definition of "comfortable" could be different than someone else's. Maybe a better approach is to answer these five basic questions:
Q. What will your expenses be?
It's almost impossible to figure out what you need to save if you don't know what you'll be spending. Draw up a monthly budget based on what you think might happen. If you downsize your home or won't have to spend as much on clothes as you do now, you may spend somewhat less in retirement. But you also might travel more and make greater outlays for leisure pursuits. Just don't expect your expenses to be dramatically lower in retirement than they are now.
Q. How long will your nest egg have to last?
This requires you to analyze several factors, including your age, medical condition, and family history. No one can predict the future, so it's usually best to plan for the worst and hope for the best. And with life expectancies on the rise, it becomes easier and easier to outlive your savings.
Q. How are you investing your savings?
It's not just how much you save that counts, it's also what you do with that money. If you invest wisely, reflecting your personal comfort level with investment risk, you may be able to stretch your savings longer. Of course, no one knows for sure how the markets will perform, but the independent research firm Morningstar projects that savings of about $1.18 million invested at 6% annually (with a 2.5% inflation rate) will provide annual income of $40,000 for 30 years. Naturally, your needs may differ.
Q. How will taxes affect your investments?
Don't forget to factor future taxes into the equation. Long-term capital gains currently are taxed for most people at a 15% rate, while those in the top ordinary income tax bracket pay 20%. But income from some investments—including municipal bonds and muni bond funds—is exempt from federal income tax. Also, remember that the tax law requires you to start taking minimum distributions from most retirement plans after age 70½.
Q. What can I do now to avoid problems?
If you're still working, you could boost your savings, utilizing tax-advantaged retirement accounts such as 401(k) plans. The compounding of the money inside your plan can help you catch up in meeting your retirement goal. In addition, you might consider postponing your retirement until you've saved enough.