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How to Set Your Retirement Savings Target

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Is $1 million still enough to retire on? You may have heard that rule of thumb and wondered if that's an accurate retirement target. It sure seems like a lot when you're trying to save and grow your funds. But what about the rising cost of health care or long-term care, you think, not to mention the question of whether Social Security will be around by the time you retire? Maybe it's not enough after all. But if $1 million isn't enough these days, what is the right amount? Is $1.5 million the magic number? Is $2 million?

The truth is, these rules of thumb don't help much, because everyone has a different financial situation and lifestyle in mind for retirement. Another big reason why it's so difficult to figure out how much money you'll need is that it's a moving target--inflation in particular makes the goal change over time, and that's just one of many variables.

But "it depends" is much too vague of an answer to get you any closer to defining a retirement goal. On the opposite end of the spectrum, many very good online retirement calculators want you to enter detail after detail about your current assets and savings rates, as well as your assumptions about different variables--all which can be overwhelming and just as immobilizing.

This article offers some concrete examples to help you get a better handle on what your retirement savings target should be. These examples will make it easier to understand how these different variables come into play.

Example: Planning for a $50,000 Annual Income in Retirement

The following table shows you how much you'll need saved in a retirement nest egg in order to draw a $50,000 annual income during a hypothetical retirement that lasts 25 years. Note that these figures are quoted in future dollars. For example, if your planned retirement date is in 20 years, you would need $1,809,434 at the start of your retirement 20 years from now under these assumptions.

Dollars Needed to Sustain a $50,000 Annual Income in Retirement

Planned retirement date

Amount equivalent to $50,000 today at retirement date

Amount needed upon retirement to fund that amount annually for 25 years

in 10 Years

$72,111

$1,254,614

in 20 Years

$104,001

$1,809,434

in 30 Years

$149,992

$2,609,609

in 40 Years

$216,322

$3,763,641

Of course, not everyone's retirement target is the equivalent of $50,000 in today's dollars, but this example gives you a benchmark from which you can adjust your target upward or downward. The most important things this table shows are the following:

  • How much money is needed to sustain a given income level over a period of years
  • How much the targets vary depending on retirement dates

A few key concepts can shed a little more light on these numbers.

Adjusting Variables: Key Retirement Planning Concepts

Here are some of the main factors you have to account for in retirement planning:

Inflation. According to the Bureau of Labor Statistics (BLS), inflation has averaged 3.73 percent a year since 1947. (There are many measures of inflation, but one of the most commonly used is BLS' Consumer Price Index for urban consumers.) That may not sound like much, but compounded over many years, it takes a big toll. That's why the equivalent of $50,000 grows so much when projected into the future. Inflation also helps explain why the amount needed to sustain retirement spending is so high, because your spending needs will continue to grow with inflation even during your retirement years.

Retirement date. Think of time as the accomplice of inflation--the longer you have until retirement, the more impact inflation will have in eroding your purchasing power. The lesson here is that if your retirement is many years into the future, don't use today's rules of thumb to assume how much money you'll need.

Return assumption. The flip side to having more time before your retirement date is that you can invest in a higher-growth, higher-risk portfolio and take advantage of compounding. In addition, on average, your remaining retirement funds should continue to grow during the years you're drawing down the funds. The table uses a 7 percent return assumption to project how much your savings and investments would keep growing in retirement. That assumes a mix of stocks, bonds, and cash equivalents and is a reasonable number based on long-term history.

However, the last decade has been a sobering reminder not to take return assumptions for granted--bond yields and bank rates were unusually low, and stocks have provided disappointing returns over the last 10 years. If you want to be more conservative, assume lower average stock returns and interest rates earned on your deposit accounts. (Checking money market rates is a good approximation for interest yield from retirement savings held in bank deposits; these rates are typically lower than long-term CD rates but are, on average, higher than rates earned on traditional savings accounts.)

Life span. This table assumes a lifespan of 25 years after your retirement date, but that's a tricky thing to assume--suppose you live 30 or 35 years in retirement. Remember, average lifespans have been growing over time, and an average means that roughly half the people exceed that number. (The U.S. Center for Disease Control and Prevention tracks statistics on life expectancy.) Plan for a longer lifespan to reduce the risk of running out of money in retirement.

Don't be intimidated if you find it difficult to get your mind around all these variables--academics and financial professionals debate each of these factors constantly. Just understand that retirement planning isn't an exact science, but the table in this article can give you some ballpark numbers to start with.

But then, get started with retirement saving as soon as possible. One thing everybody agrees on is that the sooner you get started, the more successful your retirement planning will be.