How Much Do I Need to Save for Retirement?

Everyone knows that they need to save for retirement, but most of us don’t really know which magic number to shoot for. Our goal should be to meet our financial needs in retirement and not run out of money. When you don’t know what your target is, your saving efforts will probably be wishy washy. This article presents a simple process to figure out how much you will need. There are 3 easy steps. You can choose to get complicated with this, but simple is best. This should only take you about 15-30 minutes.

1) Annual Expenses

The first step is to calculate your annual expenses for your first year of retirement. I will present the most conservative way to do this. You can use this budget calculator to determine that. Here’s another budget calculator. Calculate what you expect your expenses to be using today’s costs. Don’t get too caught up in detailed estimates. Quick estimates will suffice. Once you have your expenses calculated, then you go to an inflation calculator or this one and estimate how much inflation will increase that amount.

So if you would need $40,000 in today’s dollars, then in 20 years with 3% average annual inflation, you would need roughly $72,000. Using 3% for inflation is pretty standard. You can always use a higher number if you feel that inflation will be higher in the future. Remember to calculate in any income you think you may have such as investment income, pensions, and social security. This will lower the amount you will need.

2) What Size Portfolio Will I Need? Try The 4 Percent Solution.

“The 4 Percent Solution” is the answer to “How do I ensure I won’t run out of money in retirement?” Based on a Monte Carlo analysis, “The 4 Percent Solution” states that there is a high probability (90% confidence level) that you can maintain your lifestyle during a 30 year retirement with a portfolio that is 25 times the size of your first withdrawal. Don’t worry if you don’t understand that. All you need to know is that this is a standard way to determine your target retirement portfolio amount.

So here’s how you use this. Take the annual expenses you calculated, $72,000 in our example, and multiple by 25. So in our example your retirement portfolio needs to be at $1,800,000. Conversely, if you are close to retirement already and you know how much you have, you can determine the maximum amount that is prudent to withdraw in the first year.

If you have a $1,000,000 portfolio upon retirement, then the maximum you should withdraw in the first year would be $1,000,000 X 0.04 = $40,000. The amount you withdraw each year after that can be increased according to inflation.

If you want a higher confidence level of not running out of money during retirement, you can:

  • spend less (best method)
  • save more (good method but difficult)
  • increase income by working part time during retirement (good method, a chance to try another field of work)
  • and/or increase your income by having a more aggressive investment portfolio (risky and not recommended for retirees or those close to retirement.)

3) Create Your Savings Plan to Hit Your Target Retirement Portfolio

Use an investment calculator to determine how much you need to save monthly. In our example, you need a portfolio of $1,800,000 upon retirement. Sounds pretty daunting, huh? Let’s take a look at how doable this is.

Let’s say you start out with a portfolio of $50,000 and that you invest that money in a moderately aggressive portfolio (80% stocks/20% bonds) of index mutual funds for 30 years. (See my Guide to Investing for help with setting up your portfolio ) Let’s assume an annual rate of return of 9%. You would need to contribute $581/month to reach your goal.

Now $580 is quite a bit of money, but somehow many people are able to spend that amount of money and not even realize it. Or how about your car payment, if you have one. For many people, that is a hefty number. But notice how when you really want something, you usually find a way to pay for it. It should be no different with your retirement savings.

Even if meeting your monthly savings target is a struggle, at least you now know what to shoot for. You can slowly begin to take steps to cut back on expenses. Take a look at my post on ways to improve your financial situation for some ideas. You can also play around and tweak any of the numbers in your calculations to make it easier to meet your goal. Save what you can for now and work towards saving the amount you need. You Can Do It!

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  1. 2
    June 13th, 2007 at 7:59 am

    Excellent guide! Very useful info…I might use this myself actually.

    Just stumbled it too..


  2. 3
    June 13th, 2007 at 9:38 am

    Having spent some years working as an investment advisor in the UK and latterly advising offshore clients in Asia, the biggest problem with saving for retirement is often one of perceptions of what constitutes ‘enough’.

    Many people who are in their forties now would think that a million dollars will be enough to retire on. After all, that would make them a millionaire!

    But, dependent on the lifestyle that they want to lead and the effects of inflation eroding the real value of their savings, that just might not be the case, hard though it may be to believe!


  3. 4
    June 13th, 2007 at 11:16 am

    steve – glad you found this helpful. It really is easy to do, and once you have a target to shoot for then you can start making progress on that goal! Glad you found the post on making more text sidebar widgets helpful!

    Steve- so true. I used to work in the investment field too and it was amazing how $1,000,000 started to seem like a small amount of money when you’re talking about living on it for 30 years! We all just need to do our best to hit our target and then be careful with our money!

    Thanks for the comments guys!

  4. 5
    Lady Rose
    June 13th, 2007 at 12:40 pm

    Great info. I so need to start thinking of retirement -way over due (I’m 51) – the sooner the better to start planning and saving! Lady Rose

  5. 6
    June 13th, 2007 at 12:57 pm

    Interesting post. I like the fact that you incorporated the idea of Monte Carlo analysis and confidence levels (up to 90% probability) into the post.

    Many articles and advisors talk about annual returns and the corresponding amount you need to save for retirement but fail to realize that there are some scenarios that are far worse than others (and so it is possible that a scenario may play out where you don’t have enough money to retire).

    I’ve done a bunch of work in insurance where monte carlo simulations are extremely important in modeling catastrophe risks (even though they are rare, they still happen). It’s interesting that rare events such as a Class 5 Hurricane or Earthquake (probably akin to a huge stock market crash or a depression) do actually occur when you run say 10,000 or 100,000 simulations.

    When looking at the aggregate results you can then assess probable losses and the shape of the “curve”.

    Hopefully this kind of thinking becomes more widespread in investment thinking.

  6. 10
    Bourse Goldman
    November 20th, 2007 at 9:08 am

    Your article is good but I think you have missed pointing a major risk when planning for retirement.
    It is true that when determining the right amount you will need to save for retirement, you will have to take into account things like inflation, economic conditions of the country you live in, and market risks if you don’t have just a savings account but a 401k plan or perform any type of investing.
    Most people, clever enough to think about retirement, think about all of the listed issues. Still, plenty of people forget about another problem related to retirement savings and that is longevity.
    More people today are outliving their savings. They have predicted that they would live for example 20 years after retirement and it turns out they have been too pessimistic. Those people end up without any savings or income.
    So when you estimate how much you need to save you should always take into account this issue too (as seriously as you look at inflation) and perhaps it is a good idea that you leave a certain amount of your savings for investing so that you have some income from it in case you need it.

  7. 11
    Joy of Retiring
    December 11th, 2007 at 8:10 pm

    A lot of this advice assumes that you have a portfolio of “safe investments”.
    What happens if there is a recession or, heaven forbid, a depression – which most indicators and commentators today are pointing toward?
    You need to have passive income and alternatives to your portfolio. One such is something like this blog. You can create such a thing, based on your interests.

  8. 12
    neil strauss
    January 3rd, 2008 at 1:24 pm

    The sooner you save the better. Even a few years could mean a big difference in interest. However, the best way to plan to retire to be find multiple sources of passive income

  9. 13
    January 8th, 2008 at 3:21 am

    Any one got any advice for a 30yr old divorcee who has no children is struggling to make the monthly mortgage of 2000 and can’t sell this house. How do I get ahead and start saving some money when I still have a car note. Any advice. I wait tables currently and do real estate. I need some counciling. How much do I start saving???

  10. 14
    Joy of retirement
    January 9th, 2008 at 9:24 pm

    (hey bg, you need to downsize. Sell your car and buy an older one. Put whatever you’re not using on ebay. Start your own business – click on my name to find out how easy it is.)

  11. 15
    David Barlow
    January 11th, 2008 at 11:30 am

    I had long stints in corporate career jobs over 30 years. But a business failure in the 80′s, and outsourcing at my last firm, placed us well behind the savings curve for a liveable retirement. What caught my attention (and now my energies) were alternatives to supplement conventional saving as were mentioned in an earlier post. For us this means being able to cash flow what we don’t receive from a savings portfolio through a passive residual income business we are building. Additional diversity for our resources, and options for faster retirement income building than we would otherwise have had. How do you spell relief?

  12. 16
    January 14th, 2008 at 12:30 pm

    Excellent article! You have covered some vital information for everyone who is trying to plan for their retirement. And we all need to be reminded of the common sense ways of saving- spend less & save more-

  13. 17
    Don't retire with debt
    February 25th, 2008 at 8:26 am

    I’ve just Dugg this article.

    Great advice, especially for the debt culture that we are now living in. Never mind saving for retirement – many people will be retiring with debt! Now is definately the time to act.

  14. 18
    Oregon Retirement Community
    February 25th, 2008 at 10:11 pm

    Nice advice! I just wish I had started earlier but that kind of thinking won’t get you very far so I just need to get motivated and start saving I guess.

  15. 19
    Sheldon Vik
    June 10th, 2008 at 4:46 pm

    A few years ago it seemed like retirement was a long ways off. We both had good jobs, a 401K, and felt like we had time to save enough to retire comfortably. How quickly time has passed. Both of our retirement funds have lost money and the future looks grim. We have decided needed a plan B that would continue to bring in money to supplement our savings. Instead of relying solely on social security and savings, we have decided to try our hand at network marketing. It took several tries to realize that not every network marketing opportunity provides the kind of security we are looking for. A lot of them only wanted to take our money and offered nothing but hot air in return.
    Even though we are both computer “literate”, network marketing is a like entering a new job, and we realized we needed the support and help of a good, honest team to be a success. We have learned some really neat ways to market the five opportunities we have chosen. One of the first lessons we have learned is network marketing is just like any other job and requires hard work, time, and patience.


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