How much income will you need in retirement?
The first step to determining how much you need to save is to estimate your annual income need in retirement. A simple way to do this is to start by figuring out how much you spend each year to support your current lifestyle.
Once you get this figure, subtract expenses you won’t have when retired (like retirement savings and expenses for your children) and then add expenses you might incur (like money for additional travel or increased health care costs).
That should give you a rough idea of what you’ll need to retire in today’s dollars.
How large does your nest egg need to be?
Withdrawals from your nest egg will be needed to cover any shortfall between your retirement spending and any steady income you’ll have from things like Social Security, pensions, fixed annuities, and part-time work. For example, assume you’ll need $50,000 in retirement income and will receive $18,000 per year from Social Security. This leaves an income gap of $32,000 per year.
$50,000 Income Need – $18,000 Social Security = $32,000 Income Gap
To get a rough idea of how large your nest egg needs to be, simply multiply this gap by 25. This will calculate how much you need to have saved to cover the income gap at a 4% withdrawal rate.
$32,000 Income Gap x 25 = $800,000
In this case you’d need around $800,000 to produce the extra income you need assuming you withdraw 4% of this amount per year.
What about inflation?
These calculations estimate how much retirement income and how large of a nest egg you'd need in today's dollars. However, since the cost of everything we buy increases over time, these numbers will have to be increased by at least 3 to 4% each year to keep up with inflation.
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