How much do I need for retirement?
That is a question many people ask. And the answer changes from person to person.
What you will personally need for retirement will depend on many things. Some will depend on external factors like the economy and interest rates. Others will be determined by factors particular to you, such as your future standard of living and your health situation, just to name a couple. (Retirement planning calculator)
Unfortunately, you’ll never really know what you’ll need in retirement until you get a better handle on what your golden years will look like. If you are 20 or 30 years away from retirement now, that may be difficult to envision.
Nest egg goal: 15 times your annual income?
But regardless of what the future holds, it is important that you set retirement goals early so you not only have something to strive for, but are also in a better position to make adjustments when a clearer picture of your retirement emerges later in life. (Related: A retirement roadmap)
With so much still unknown, consider setting a goal for your retirement nest egg of about 15 times your current salary. While such rules of thumb are not absolutes or appropriate for each and every person, they do provide a pragmatic starting point for planning.
Perhaps just as useful, setting an initial retirement goal will help you develop an overall financial plan, like the 5-10-15-20 strategy for financial goal setting. This is where your retirement goal can fit with other goals, including:
Establishing a retirement goal is a fundamental part of the strategy.
Do some retirement math
During retirement, if you were to take growth as retirement income – without withdrawing from your nest-egg principal – you may have a better chance of having both money to meet your retirement needs and a potential legacy for your loved ones.
For discussion purposes, if we assume an annual rate of growth of 5 percent on your nest egg, a corresponding mathematical equation could be: (Income X 15) X 0.05 = (Income x 0.75). Using this formula, and regardless of what your income may be, a 5 percent return (0.05 in the above equation) on your nest-egg of 15 times your income would equal about 75 percent of your current gross income.
And any growth in value – which you could take as retirement income – is in addition to any other sources of retirement income you may have, including Social Security, pensions, or part-time and freelance work.
Eventually, your retirement nest egg will be made up of many different assets, including your savings and investments, real estate or other tangible assets, and tax-qualified savings vehicles like individual retirement accounts (IRAs) or employer-sponsored retirement plans, such as 401(k)s.
If your employer does offer a 401(k) or similar plan, it is often the most expedient way to get started building your nest egg. In most instances, your contributions to a 401k are tax deductible and thereafter grow tax deferred. You’ll also enjoy long-term compound interest and, in some cases, an employer match.
Another option to consider is an IRA, either a traditional IRA or a Roth IRA.
- With a traditional IRA, your contributions may be tax-deductible, and earnings in the account grow tax deferred until you start taking withdrawals.
- With a Roth IRA, your contributions are made with after-tax money, so they are not tax deductible, but earnings grow tax deferred and withdrawals are tax free, if certain conditions are met.
Both types of IRAs are useful ways to supplement any employer-sponsored retirement plan you may have, as well as let you gain access to a wider choice of professionally managed investments. (Related: DIY planning with IRAs)
Of course, retirement plans are just one part of the equation. You should have an overall financial strategy that takes into account debt, savings, and income considerations as well.
Many people opt to talk to a financial professional to put a plan together.
In the meantime, the sooner you begin contributing to a 401(k) or IRA and building your retirement nest egg, the faster - and larger - your retirement funds could grow. Conversely, the longer you wait, the harder it will be to catch up.
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This article was originally published in December 2016. It has been updated.