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Saving for retirement is an essential part of a secure financial plan. But while there are rules of thumb you can follow, there's no one-size-fits-all number to target.
To determine how much you need to start saving now for retirement, you'll need to have an idea of when you want to leave the workforce. Also, it's important to think about what kind of lifestyle you want to have when you're retired.
Estimate How Much You Need to Save
Everyone is different, and your retirement goals may not be the same as the goals of your friends or family members. And frankly, there's no getting around that retirement planning is built on a bunch of assumptions.
While those goals can change over time, you want to make the most educated guesses possible, and use them to adjust your savings plan accordingly. Here are three steps to help you create your plan:
1. Consider Your Lifestyle
Some people plan to downsize their lifestyle in retirement. A survey of retiree spending by the Employee Benefit Research Institute found that in the first two years of retirement, median household spending dropped by 5.5% from pre-retirement spending levels, and by 12.5% after four years of retirement.
Simply not having to save for retirement anymore—whether through your company's 401(k) or an individual retirement account (IRA)—can reduce how much money you'll need. Also, aiming to pay off your mortgage before you retire would also reduce your living costs.
Still, not all retirees have a big drop-off in expenses. Health care costs tend to get higher the older you get, and you may want to replace some expenses, such as retirement savings or a mortgage payment, with travel and other activities.
It's also important to consider how long you'll need to live off of retirement savings. According to the Social Security Administration, A 65-year old woman today has a life expectancy of 21.5 more years. For a 65-year old male, life expectancy is 19 more years. What's more, roughly a third of all 65-year-olds will live past 90.
So as you determine how much money you'll need each month to live comfortably and do the things you want in retirement, you'll need to multiply that by how many years you expect to live past retirement age. And, in general, it's best to be as conservative as possible to avoid putting yourself in a position where you run out of cash.
2. Decide When You Want to Retire
Just as your life expectancy helps determine how much you need to save, so does your retirement age. The sooner you choose to leave the workforce, the longer you'll be living off of your savings, so you'll need to have an idea of how old you'll be when you make the transition.
And if you're thinking about working longer than the traditional retirement age, you've got plenty of company. According to the Employee Benefit Research Institute, more than half of today's workers expect to still be working past age 65. Yet less than 15% of today's retirees worked past 65.
Keep in mind, though, that it's difficult to predict the future, and retiring before 65 may be inevitable. Illness, layoffs or needing to care for a family member can push people to retire earlier than expected.
3. Calculate How Much to Save
Investing experts generally recommend saving 15% of your gross income or more toward retirement, but understanding your retirement goals can give you a better idea of the right savings rate for you.
As you think about your lifestyle, health care expenses, debt obligations and other costs, come up with an amount you expect you'll need in today's dollars to cover those expenses without putting you in a difficult financial position.
Then use a retirement calculator such as those from investment firms Vanguard, Charles Schwab or Edward Jones to input your assumptions about income needs and debt to determine how much you need to save now to reach your goal.
Also, keep in mind that you can take full Social Security benefits at age 67. If you're not sure how much of a benefit you'll receive, you can register for a my Social Security account to get an estimate based on your earnings.
That said, avoid the temptation to rely fully on that estimate. The U.S. Congress has made changes to the normal retirement age for Social Security before, and the Social Security Board of Trustees projects that the program will only be able to pay 75% of its scheduled benefits by the year 2035.
So while it can be a nice supplement, don't take the estimate at face value—focus on your savings, and consider any Social Security benefits you might receive as a bonus.
Types of Debt to Consider When Planning for Retirement
As you work through the numbers of what you'll need to save to retire when and how you want, it's a good idea to work on paying down debt. Not only will it give you more freedom with your cash flow, but it can also reduce the amount of income you'll need each month.
Specifically, there are three types of debt to consider paying down as you work to plan your retirement.
Baby boomers—those between ages 55 and 73—have the second-highest debt burden of any generation, according to Experian data, and mortgage debt makes up a big chunk of it.
By owning your home free and clear before you enter retirement, you can save yourself hundreds, if not thousands, of dollars every month—that's money you can use to fund travel and other activities, or just not have to save for.
The student loan debt crisis is getting worse, and recent college graduates aren't the only ones suffering. According to Experian data, baby boomers saw a 7% increase in their student loan balances in the past year, at least some of which is attributable to parents taking out loans to fund their children's education.
Student loan debt can be tricky because it's more difficult to get rid of than other types of debt. It's virtually impossible to get it discharged in a bankruptcy, and defaulting can cause significant financial problems and result in garnishment of your Social Security benefits.
Credit Card Debt
The biggest threat credit card debt poses to your retirement is its high cost. According to the Federal Reserve, the average credit card interest rate is 17.14%, and with no set repayment period, it's easy to rack up a balance and carry it from month to month for years.
By eliminating credit card debt, you can avoid unnecessary interest charges that can linger far too long.
Contribute to a Retirement Plan Early
The sooner you start saving for retirement, the better because it gives your investments more time to grow. Again, how much you need to be saving depends on your retirement goals. But as a rule of thumb, Fidelity Investments suggests having the following saved at different age milestones along the way:
- Age 30: 1X your salary
- Age 35: 2X your salary
- Age 40: 3X your salary
- Age 45: 4X your salary
- Age 50: 6X your salary
- Age 55: 7X your salary
- Age 60: 8X your salary
- Age 67: 10X your salary
As you consider how much to save, take some time to consider the different retirement options. For example, a 401(k) plan is an employer-sponsored retirement plan that allows you to save through automatic deductions from your paycheck.
In some cases, your employer may even match some or all of your monthly contributions to your account, directly increasing your savings rate. Those contributions won't be included in your gross income when you file your tax return.
Another option is an IRA, which is a self-directed investment account. With a traditional IRA, you may be able to deduct the contributions you make from your taxable income, but you'll pay taxes later when you take withdrawals from the account.
With a Roth IRA, on the other hand, you'll be taxed on the contributions you make right now, but you'll be able to take tax-free withdrawals in retirement.
As you establish your retirement savings strategy, research the different savings options and choose the best ones for your situation.
Do You Need a Good Credit Score to Retire?
No one's going to check your credit score when you decide to finally hang up your hat. But your credit score can have a significant impact on your ability to retire when and how you want.
Right now, for instance, having a good credit score makes it possible to qualify for low interest rates when you borrow money—whether it's for a home, a car or something else. Lower-cost loans give you more room to save for retirement. Your credit score can also affect your monthly premiums for auto and homeowners insurance.
These same situations can also come up during retirement. If you decide to move, renovate your house, buy a car, get a loan for health care expenses or apply for insurance, a good credit score will provide more savings, which are essential when you're on a fixed income.
Start Your Planning Sooner Than Later
It can be easy to put off planning for retirement, especially when it's still decades away. But the sooner you get a plan in place and start executing that plan, the better off you'll be in the long run.
As you work on creating your retirement plan, also be sure to check your credit score to see if there's room for improvement. If there is, take some time to work on improving your credit. It can take a while to get to where you want to be, but the resulting savings can make it easier to save for retirement and reduce your expenses once you get there.