When tackling the question of how much money to have saved up for retirement, there are 2 ways to think about this.
The first is what I’d call the stockpiling mentality. The thought here is you save diligently until your funds reach a certain monetary level, usually your comfort zone for retiring.
For example, many people in the past identified $1 million dollars as their target savings before they would retire.
Bottom line, this is usually an arbitrary number, and the downside is that it doesn’t truly answer the question of whether or not that million dollar stockpile will be able to meet your needs throughout your lifetime. It may not be enough, or it could even be too much.
This is why I believe that it’s way more helpful to attack the savings question by thinking about your spending plan. Remember, the ultimate goal of your retirement savings plan is to make sure you can generate the income you need to live on for as long as it’s needed. So with this thought process your expenses equal a monthly income need. Then working backwards you figure out how much money you have to save in your nest egg to meet those needs.
Here’s a simple example: if your expenses are $4,000 a month with annual inflation of 3%, and you expect to live ~30 years in retirement and earn about 5% annually, you would need to save ~$1.1 million in your nest egg. This is also assuming you have no other sources of retirement income (such as Social Security or a pension) to meet that goal.
You still end up with an end target value, but this time it’s based on your real circumstances rather than an arbitrary number. And while it may take a few extra steps, thinking about your savings goal as a means to meet your expense needs ultimately provides more certainty in retirement.
With this little change of thought apparently comes more peace of mind: in a recent survey, approximately 84% of working Americans said they would have more confidence and a better sense of control preparing for retirement if they knew how much future monthly income their savings would produce.
So the next time you open your 401(k) statement, don’t just check if the balance is up or down from the last reporting – keep the long-term goal of future income needs in mind and make plans accordingly.