Saving for retirement, and living comfortably through your retirement years, is a complex topic. So many factors impact the amount of money you may need, and most of them you can’t accurately predict. Of course, it’s better to have more than you need instead of not saving enough and running out too soon. To simplify things, financial planners devise “percent rules” to guide future retirees toward saving specific amounts, usually suggesting at least ten percent of your pre-tax income annually to ensure a secure retirement.
That flat amount is a vast generalization. Realistically, your retirement needs will depend on multiple factors, including your life expectancy, whether you will have a mortgage, what your financial obligations are, and more. Many financial planners suggest that you should aim to replace eighty percent of your current income to live comfortably in retirement. However, if you take a close look at your current budget and adjust it for changes that will come after retirement, you should be able to get closer.
For example, suppose you spend $3,000 monthly on your mortgage, but you intend to pay off the mortgage before your planned retirement. That fact makes a notable difference in how much you need to have available. Other potential savings include the cost of commuting, workday lunches and clothing, and perhaps other items. On the other hand, you may need to increase the travel budget if that is a retirement goal since you will have more time available than you do while holding down a full-time job.
Once you determine how much you need monthly in retirement, you can calculate the total assets you should accumulate to support that income stream.
The 4 Percent Rule Is about Spending, Not Saving
The four percent rule is about withdrawing from your retirement savings and still having it last through your life instead of helping you save enough money before you retire. Of course, if you overspend in the early years, you could run out. But, on the other hand, if you are too frugal, you could deny yourself the potential to enjoy your golden years. You can’t take it with you, after all.
Suppose you have that theoretical million-dollar retirement account. If you follow the four percent rule, you will withdraw four percent in your first retirement year, or $40,000. The following year, you adjust for inflation, withdrawing $40,000 plus whatever inflation adds to that. For example, if inflation is at three percent, the second-year withdrawal would equal $41,200. Each year, you would withdraw the same $40,000 plus whatever inflation adds, regardless of how much or little the investments have grown. Clearly, inflation will affect your retirement spending just as it affects the purchasing power of income while you are working and earning.
The four percent rule (like the ten percent rule for saving) is a good general benchmark. However, it's probably best to think about it as a guideline that you want to customize for your specific situation. Your expenses, retirement income stream, tax situation, and assets will affect the sustainability of your retirement savings over the long term. Therefore, it's a good idea to reevaluate spending regularly to be safe.
