Saving for retirement is the granddaddy of all financial goals because it requires a considerable nest egg. But knowing how much you really need to retire is more like an art than a science. It’s similar to planning a big party when you don’t know when or where it will be, how many people will show up, or how long it will last!
In other words, retirement planning has many variables and no one-size-fits-all answer for how much you should save. But I’ll make it super simple in this article by explaining different sources of retirement income and how much money you’ll need to create a comfortable, secure future.
How much money do I need to retire?
Having enough money to retire is critical to continue enjoying a good lifestyle even after you stop working. Most people reach an age when they’re ready to slow down or unable to work due to poor physical or mental health. Or you might be a super saver and “retire” early when you reach financial independence and no longer need to earn an income to fund your dream life.
A secure retirement is one with enough savings and investments to preserve some or all your pre-retirement income or standard of living. You’ll probably want to buy the same food, shop for the same clothes, and enjoy the same hobbies as before retirement. But you may downsize to a less expensive home or have fewer expenses; however, some costs, such as medical bills and travel, could increase significantly.
Many financial planning models recommend having 70% to 80% of your pre-retirement income after you stop working. For instance, earning an average of $100,000 a year in the years leading up to retirement might require a minimum of $70,000 a year to enjoy a good retirement lifestyle.
However, the lower your income, the more difficult it may be to live on less in retirement.
I aim to have no less than 90% of my income, ideally 100%, in retirement. Some of my expenses may drop in the future, but I’m not planning on reducing my standard of living by much and I plan to travel much more.
If you have high aspirations for retirement, such as owning a second home or traveling extensively, there’s nothing wrong with planning for more than 100% of your pre-retirement income. Also, your future debt—such as a mortgage or student loans for a child’s college—should be considered.
Let’s cover typical income sources and how much you’ll need to ensure you never run out of money in retirement.
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How much will I receive from Social Security in retirement?
Before you can determine how much money you need for retirement, it’s important to account for what you’re going to receive from Social Security and any other income, such as a pension. If you’re just starting your career, you may not have enough information about your future benefits to fully consider it in your plan, but it’s still important to understand how the system works.
Social Security retirement benefits are an excellent source of income for most eligible U.S. workers. The program is a group of benefits for people who are retired, disabled, or survive a relative receiving benefits. Note that workers covered by a different system, such as federal and railroad employees or state workers who qualify for a pension, are not eligible for Social Security retirement benefits.
Social Security gets funded by payroll taxes and the self-employment tax. If you’re an employee, you may see the deduction listed on your paycheck as OASDI, which stands for old-age, survivors, and disability insurance.
How do you qualify for Social Security?
To qualify for Social Security retirement benefits, you must work for 40 quarters or at least ten years. The calculation for how much you’ll receive is based on the average of your highest 35 years of earnings. If you worked under 35, the missing years get factored in as $0 income. And if you worked more, only your highest-earning years get considered.
The Social Security program taxes your earnings up to an annual threshold, known as the wage cap, which has increased over time. For 2023, the Social Security tax for employees is 6.2% of earnings up to $160,200. Your employer also pays an additional 6.2% on your behalf. For 2024, the wage cap rises to $168,600.
If you’re self-employed, you pay into the Social Security system on your own at the full 12.4% (6.2% + 6.2%), up to the same amount of annual income. If your income exceeds the annual threshold, it’s no longer taxed until the following year. For instance, if you earn $200,000 in 2023, you pay Social Security tax on $160,200 but not the remaining $39,800. But you start paying tax again on January 1.
The Social Security retirement benefit you receive varies widely depending on the age you claim it. The full retirement age has gradually increased because we live longer. If you were born between 1937 and 1959, your full retirement age is 66. But if you were born in 1960 or later, it’s 67.
Should I take retirement benefits early?
However, no matter when you were born, you can elect to take early retirement benefits as soon as 62. The problem is that you receive a permanently reduced benefit, so taking early retirement isn’t always the right decision.
Let’s say you earned more than the annual Social Security threshold for most of your career. If you fully retired in 2023 at age 66, your maximum monthly benefit would be $3,627. But if you’re 62 in 2023 and took early retirement, you’d receive $2,572, about 30% less for the rest of your life.
To increase your payout, you can delay retirement until age 70. If you retire at 70 in 2023, your maximum benefit would be $4,555. That’s about 25% more monthly income than starting benefits at your full retirement age. And 77% more than taking an early retirement! So, if you can wait several years for benefits, it’s a simple way to lock in a more secure retirement that adjusts annually for inflation for the rest of your life.
Again, those monthly benefits reflect the maximum if you were a high earner throughout your career. If you’re a middle-class American who fully retired in 2023, you could expect an average monthly benefit in the neighborhood of just under $1,800. And the average is about $1,700 for those claiming an early retirement in 2023.
Can I count on Social Security retirement benefits?
If you’re worried that the future of Social Security is in jeopardy, don’t be. It has a reserve fund, and minor policy changes—such as increasing the payroll and self-employment tax or increasing the annual wage cap—can raise revenue to keep the program healthy.
Once you reach age 25, Social Security statements are mailed out each year, about three months before your birthday. After you’ve worked long enough to qualify, which as I mentioned is ten years, the statement includes an estimate of your future income.
Remember that if you take time off from work, your benefit can go down, or if you get a raise or a second job, it can go up. Also, any earnings that don’t have Social Security taxes withheld won’t appear on your statement or be factored into your future benefits. That’s just one reason why hiding income from the IRS is a bad idea!
If you want to learn more about Social Security, go paperless, check your earnings history, and see your estimated future retirement income, create an online account at SSA.gov. Review your reported earnings for errors because mistakes could keep you from receiving all the benefits you’re entitled to.
Can I count on Medicare benefits?
Medicare is another important federal program for retirees because it dramatically cuts the cost of healthcare–but it doesn’t cover all health costs. To qualify for Medicare, you must be at least 65 or younger with specific disabilities.
Like Social Security, you pay into the Medicare program through payroll and self-employment taxes. However, there’s no Medicare wage cap–it applies to your entire income. Both taxes get collected together and are called the FICA tax, which is short for the Federal Insurance Contributions Act.
The Medicare payroll tax rate for employers and employees is 1.45%, or a total of 2.9%–and self-employed people pay the full 2.9%. Added to Social Security, the total payroll withholding rate for 2023 is 7.65% (6.2% + 1.45%) for employers and employees. The self-employed pay the full tax amount, or 15.3%.
Medicare coverage has two parts called Part A and Part B. Part A is hospital insurance that helps cover you for care including inpatient hospital stays, skilled nursing care, hospice care, and certain healthcare costs. Part B is medical insurance that helps cover costs like doctor’s services, preventive care, outpatient care, and medical supplies.
Medicare has a more extended alphabet, including Part C, which is also called Medicare Advantage, a plan offered for retirees by private insurers. It gives you all the benefits of Parts A and B, plus extra benefits, like dental and vision insurance, for an added cost.
Private insurers also offer Part D to help cover the cost of prescription drugs for an additional premium. Those extras are called supplemental insurance because they cover healthcare expenses not covered by the federal Medicare program.
The amount you pay for Medicare depends on your income and the coverage you choose. Part A hospital coverage is free for most people who worked for at least ten years. Part B medical has a monthly premium of $164.90 in 2023. However, you may pay more with a high income. Part C Advantage plans typically have a monthly premium based on benefits. In this case you don’t have to pay a Part B premium.
In addition to various Medicare premiums, retirees must pay copays, deductibles, and coinsurance for services based on their chosen coverage. To learn more about Medicare costs and benefits, visit Medicare.gov.
How do I grow a retirement nest egg?
While having some Social Security income and Medicare benefits to rely on in retirement is great, it’s typically not nearly enough. The programs were designed to be a safety net, not a sole source of income or healthcare for retirees. That’s why creating your own retirement income is vital.
If you’re one of a declining number of employees with a pension, consider yourself fortunate. A typical pension pays about 2% of your income for every year worked. For example, if you stay with your company for 20 years, your future benefit might be 40% of your pre-retirement income. But pensions have fallen from favor because they’re costly for companies who must pay 100% of a worker’s benefit.
Instead of a pension, most workers can contribute to one or more tax-advantaged retirement plans, such as a 401(k), 403(b), or 457 plan. But don’t worry If you don’t have a retirement plan at work or are self-employed because you have other options, such as an IRA, SEP-IRA, or solo 401(k). All these plans cut taxes and make it easier to build a nest egg.
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Factors for retirement savings
How much you’re able to accumulate for retirement depends on many factors, including:
- Your investment return
- Your account fees
- How much you contribute
The only factor you can control is how much you contribute to a retirement plan. If you start relatively early, I recommend saving at least 10% to 15% of your gross income in a tax-advantaged retirement account. If not, you may need to save 25% or more to catch up on retirement savings.
While no one likes paying fees on your retirement investments, they’re unavoidable. Companies that manage investments and administer retirement plans have many expenses to cover. Therefore, you should be mindful of choosing low-fee investments so they take as little of your earnings as possible.
Your investment return depends on the investments you choose. I recommend picking passively managed, low-cost funds, such as index funds, that are highly diversified and aim to mirror the performance of a particular index or financial market.
The value of index funds goes up and down in the short term; however, over time, the market has risen nicely. For example, from 1950 to 2023, the S&P 500 rose an average of over 11%. You could accumulate a massive retirement account even if you invest consistently and earn a lower return.
Young investors should typically own mostly stock funds because they give higher returns over the long term but can be volatile in the short term. There are also bond funds, which are more conservative with lower returns. As you approach retirement, you’ll want to own less stock and more bonds to protect your account from potential losses.
READ ALSO: 10 IRA facts everyone should know
How much money do I need to retire?
How much money you need to retire depends on the income you plan to spend in retirement. Most people must accumulate about eight to 10 times their annual income to generate enough retirement income. For example, if you earn $100,000, having $1 million to kick off your retirement is a good goal.
Let’s say you earn $75,000 and want to retire at age 67 with 80% of your pre-retirement income, or $60,000. You can probably count on getting about $20,000 a year from Social Security, and the remaining $40,000 must come from savings.
Assuming you’ll live 30 years and continue earning a conservative rate of return on your nest egg, getting income equal to 5% per year is reasonable. If you divide your annual desired income by this rate, that’s a total savings of $800,000 ($40,000 / .05 = $800,000).
Another way to determine your needed savings is to multiply your pre-retirement income by ten, which equals $750,000 ($75,000 x 10), in my example, getting you close to the same number. But if you want to have 100% (instead of 80%) of your pre-retirement income, you’d need about 14 times $75,000 in savings, or just over $1 million. Shooting for 15 times, or $1.1 million, would be a good target.
Many retirement planning unknowns exist, but these basic calculations give you an estimated goal. If you’re not on pace to have what you’ll need for retirement, it’s time to increase your savings rate. One way to make sure you’re on track is to have a savings goal based on your age, such as a balance equal to:
- Your annual salary by age 30
- Two times your salary by age 40
- Four times your salary by age 50
- Eight times your salary by age 60
- Ten times your salary or more by age 66 to 67
But these are very general guidelines, so don’t worry if you don’t have that much for your age. As your income, debt, and lifestyle change, reevaluate how much retirement income you’ll need and whether you’re saving enough to achieve it. You might have other assets, such as a paid-for home, a part-time job, or business income in retirement, to help boost your income.
Learn more financial tips to help you save money, get additional tax benefits, and make the most of your insurance, credit cards, and retirement accounts for more success in the New Year. Listen in this player:
8 factors that affect how much you need to retire
Here’s a list of eight considerations when planning how much you’ll need for retirement.
- Your retirement age – is critical because the earlier you need income, the more you’ll need to save. Most people use the age at which they’ll start receiving Social Security as a default. But if you accumulate a large nest egg, it’s possible to retire much earlier.
- How much you’ve saved already – plays a significant role in your nest egg’s size. The sooner you begin saving, the more compounding interest works in your favor to grow your balance.
- Your average pre-retirement investment return – determines how quickly your balance can grow. For example, investing $200 monthly for 40 years at a 3% return would grow to $185,000. But if you got an 8% return, you’d have $700,000.
- Your post-retirement investment return – is also crucial because you need to keep your savings working for you. But you’ll want to keep your nest egg safe in low-risk and low-return investments once you retire.
- How much Social Security you’ll receive – or other income, such as a pension, is critical for accurate retirement planning. For typical workers, Social Security may replace 30% of your pre-retirement income.
- Inflation – causes prices to rise, which makes your retirement income less valuable. It’s good to know that Social Security retirement benefits get adjusted for inflation as the cost of living increases.
- Your withdrawal rate – is how much money you take out of your nest egg each year. Many people believe they can live on less than their pre-retirement income. But if you dream of lavish trips, living in an expensive area, or think you’ll need costly medical care, you may need more income in retirement. A high withdrawal rate means your retirement money may not last as long as with a lower one.
- Your longevity – is the biggest unknown when it comes to planning for retirement. If you’re relatively healthy at full retirement, statistics show you’ll live well into your 80s. If you have a good family health history and take care of yourself, you could need retirement income into your 90s.
If all these unknown future variables for retirement planning make your head swim, here’s a simple solution: save no less than 15% of your gross income from every paycheck to a tax-advantaged retirement account. That will reduce taxes, grow wealth, and create long-lasting financial security for a happy retirement.