When you think about retirement, you probably envision white sand beaches, flip flops and drinks with umbrellas. Or at the very least, not having to wake up to clock in at 9 a.m.
But the fantasy is only a small part of the retirement equation. Much of retirement planning is a numbers game. And to have enough money to support your post-work fantasies, you’ve got to have a plan.
Here’s how to financially plan for retirement.
How much do I need to retire?
When preparing for any financial goal, it’s easiest to start with the end in mind. With some things, like house or car down payments, the number is somewhat easy to peg.
But funding decades of fun? It’s harder to figure out any one number for that. How much will semiannual cruises cost? Or snowbirding in Florida? Here are a couple of common (and easy) ways to get started.
The 80 percent rule
If the prospect of tallying each cost and expense you’ll incur in your Club Med years is intimidating, fall back on this old standard. For years, experts have said that we’ll probably want between 70 and 80 percent of our pre-retirement income in retirement.
Why not all of our current income? Well, this rule of thumb relies on a few assumptions, namely that your expenses will be considerably less in your golden years than they are currently. Later in life, you probably won’t be paying for childcare or college, and you may have finished paying off your mortgage or other large debts. That said, if those situations don’t apply to you, you may require more of your income in retirement and may want to up your percentage.
To calculate how much you’d need in retirement, then, you’d take 70 or 80 percent of your current income and multiply it by at least 20, the average amount of years Americans live after they retire.
So, if you earn $50,000 today, you’d want to have at least $700,000 to $800,000 to draw on in your retirement.
Multiply current spending by 25
Rather than focusing on your current salary, some financial advisors encourage clients to hone in on their spending. If you currently spend $30,000 a year, then, you’d want to have at least $750,000 in retirement.
While 25 might seem like an arbitrary number, it’s grounded in another retirement planning rule of thumb: the 4 percent rule.
The 4 percent rule is a common estimate for how much someone can withdraw from an investment portfolio without touching the principal. That’s important because the principal, or the base amount of money you have when you retire, is what will generate most of the returns you’ll rely on without a job for income.
We multiply expenses by 25 because that’s the fastest way to calculate the value you need to end up with to make an annual withdrawal equal to your current expenses. If you have $750,000 in retirement savings, for instance, a $30,000 withdrawal is equivalent to 4 percent of your total.
The 4 percent rule operates on one big assumption, though: Over the long term, it assumes an investment portfolio will earn at least 4 percent annual returns. While that’s very reasonable for an S&P 500 index fund, which historically earns 7 percent each year on average when adjusted for inflation, chances are your entire portfolio won’t be in stocks when you retire.
You’ll probably have more bonds and bond funds, which offer more stability in value but lesser average returns. That means a more conservative retirement portfolio with a greater percentage of bonds may not provide the level of returns necessary to maintain 4 percent withdrawals over your retirement.
If you’re concerned about investment earnings not reaching at least a 4 percent threshold, you might consider using 3 percent as your base instead. In that case, to get your retirement portfolio value target, you’d multiply your current expenses by 33.33 instead of 20.
How can I fund my retirement?
You’ve estimated what you may need to fund your days at Shady Pines. Now, how exactly do you do it? Well, there’s another rule of thumb to fall back on.
The 15 percent rule
Getting to your retirement goals may be as easy as investing 15 percent of each paycheck, according to research from Fidelity. Saving 15 percent will position most of us to have around 70 percent of our income when added to Social Security.
This, of course, relies on a couple of assumptions—namely, that you start investing at 25. While that’s not possible for all of us—surveys have found the average age that Americans actually start investing for retirement is 31—a later start means bumping up that contribution percentage some. If you wait a decade, you’ll probably want to shoot for 20 to 25 percent.
If those percentages seem daunting, remember that even small amounts add up over time. A 1 percent increase in your 20s could add up to a 3 percent greater retirement fund, according to Fidelity’s research. And luckily, when it comes to paying for retirement, you aren’t in it alone. You’ll be relying on some of your own savings, yes, but you can also factor in Social Security payments.
Portions of each of your paychecks go to fund Social Security, and when it comes time for you to retire, the Social Security Administration calculates what value you will receive based on your earnings history and your retirement age. While you can start receiving Social Security benefits at 62, they’re slightly prorated unless you wait to start taking them until 67 for those born after 1960.
Your exact payment will vary year to year based on cost-of-living adjustments and the average amount you earned during the 35 years you made the most money. Individual calculations can get tricky, but the Social Security Administration offers benefits estimators to help you figure out how much you might get.
For reference, the average estimated benefit in 2020 is $1,503 a month, though high earners who file to get benefits at age 66 might get up to $3,011 a month. Someone earning an average of $50,000 might receive between $1,289 and $2,276 a month, depending on when they started taking Social Security payments.
Keep in mind that while Social Security benefits can lessen the amount you need to save for retirement on your own, you probably do not want to rely on them entirely.
401(k)s and IRAs
In addition to Social Security, you’ll probably also want to make regular contributions to a workplace retirement plan, like a 401(k) or 403(b), or an individual retirement account (IRA). Workplace retirement plans and IRAs reward retirement savers with certain tax advantages. In addition to tax-free growth of the base amount of money you invest, depending on whether you have a Roth or a traditional IRA account, you may be able to deduct contributions from your current tax payments or make tax-free withdrawals.
You also may get free contributions toward your retirement from your company if you have a match. If you are eligible for a match, make sure you’re contributing at least enough to receive it. That’s free money.
If you haven’t started investing for retirement yet, Acorns Later offers traditional, Roth and SEP IRAs that automatically adjust as you age to help provide you with the income you need in retirement. We'll automatically select the right type of IRA for your lifestyle and goals.
If you’re enrolled in a high-deductible health plan (HDHP), you can invest money today for future health expenses through Health Savings Accounts (HSAs). This makes HSAs a powerful retirement planning tool because health expenses may end up being 15 percent of retirees’ annual costs—which may add up to more than a quarter of a million dollars over time.
According to Fidelity research, retired couples may need to plan for $285,000 of health-related costs. HSA contributions can be deducted from your taxable income today, grow tax free like IRAs and 401(k)s and are not subject to taxes on withdrawal as long as they’re used for health expenses.
Taxable brokerage accounts
You aren’t limited to workplace retirement plans or IRAs when you’re investing for retirement. If you’ve exceeded the annual contribution maxes for your 401(k) or IRA, you may choose to invest for retirement through a taxable brokerage account, like Acorns Invest.
While taxable brokerage accounts don’t offer the same potential tax advantages as workplace retirement plans or IRAs, they still provide your money with exposure to the wealth-generating potential of the stock market.
The bottom line
Planning for retirement expenses doesn’t have to be time consuming or exhausting. General guidelines provide a framework to start saving for the boss-free chapter of your life. With the right investment accounts and contribution rates, you can reach your retirement goals stress-free.
Investing involves risk including loss of principal. This article contains the current opinions of the author, but not necessarily those of Acorns. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.