Think about your retirement dreams and realities to set a savings goal for the future.
By Rachel Hartman, Contributor
IN THE PAST, saving $1 million for retirement was considered a benchmark to help you enter retirement comfortably. But times have changed, and that figure may no longer be accurate. “Boomers and the subsequent generations are dealing with a different puzzle than their parents,” says Steven Barrett, a financial consultant with Xceed Wealth Management Group in El Segundo, California. Many companies no longer offer a traditional pension plan to employees. Instead of relying on a pension, most people entering retirement will depend on what they have saved in a 401(k) plan and IRAs.
“This shift in retirement funds alone is enough to upset the longstanding $1 million milestone, but when you add in the low interest rate environment we’ve been in for quite some time, it’s important to build savings rather than relying solely on the interest growth,” Barrett says. Longer life expectancies, along with potential obligations to care for older or younger family members, could further shift the amount you’ll want to set aside.
Here are some guidelines to use when defining how much you need in your retirement nest egg.
Consider what the golden years mean to you. While you may want to save more than $1 million for retirement, you might be happy with substantially less. Start by envisioning how you would like to live in the future. “Some people imagine a time where they do not work but expect a nice quality of life, including a generous travel allowance,” says Tamra Stern, director of wealth management at Main Street Research in Sausalito, California. “Others simply want to quit working as soon as possible and are willing to have a more pared-down lifestyle.”
Think about future household expenses. Once you have an idea of the lifestyle you’d like to pursue, estimate your basic monthly costs. Be sure to include mortgage payments, property taxes, new vehicle expenses, food costs, travel goals and other hobbies. Keep in mind that medical expenses could be a large part of your retirement budget. You’ll likely have access to more advanced health care than what was available in the past, but those procedures and medicines can come with a high price tag. “Long-term illness could set you back $40,000 to $100,000 per year if you need home health care or facility care in your golden years,” says Jon Ulin, managing principal of Ulin & Co. Wealth Management, a branch of LPL Financial in Boca Raton, Florida.
If it’s difficult to estimate future costs, talk to a financial advisor about your overall goals. You can also compare yourself to the average retiree. Households run by those age 65 or older spend an average of $45,756 each year, according to 2016 data from the Bureau of Labor Statistics. That’s about $3,800 a month.
Don’t overlook family members. You may not currently support an aging parent, but in the years ahead you might need to cover certain health care expenses for elderly relatives. Or you could feel compelled to fund a grandchild’s education. “With many people living longer lives and becoming part of the ‘sandwich generation,’ with multiple generations of family members taking care of each other, contingency planning should be an important part of your planning,” Ulin says. If you’re just a few years away from retirement, you might decide to work longer before retiring to cover a relative’s expenses. Or you might opt to cut back on other areas of your lifestyle to pay for an important family event.
Take a hard look at income. After spending some time thinking about your lifestyle and costs, you’ll want to set up a plan to cover retirement expenses. “Determine your fixed income sources in retirement,” Stern says. In addition to Social Security, these might include annuity payments and rental income.
As you consider distributions from investments, evaluate the percentage you want to work with. If you plan to have $1 million in retirement accounts and withdraw 4 percent each year, you’ll receive $40,000 a year. If you’ll need more than that to cover expenses, you’ll want to save more now to increase the amount.
You may find you’re more comfortable withdrawing a lower percent each year. “With today’s ultra-low interest rates and increasing stock market volatility, retirees may want to reconsider the ‘4 percent distribution rule’ and instead focus to lower their ongoing investment income closer to 2 to 3 percent a year from their diversified portfolio,” Ulin says. This would mean withdrawing $20,000 to $30,000 each year from a $1 million nest egg.
Remember future taxes. As you calculate the income you’ll have during retirement, keep in mind federal and state taxes could chip away at your cash flow. If you put aside cash in a traditional IRA, your contributions are tax-deductible, but you’ll pay taxes on the distributions.
To reduce the amount of taxes you’ll need to pay during retirement, “Save money using tax-advantaged strategies,” Barrett says. This could include setting aside funds in a Roth IRA. While you won’t have a tax break now on the contributions for a Roth IRA, the earnings and withdrawals are usually tax-free.
Run the numbers with inflation. With prices increasing from year to year, it’s important to consider these rises when planning your nest egg. “Your most significant risk in retirement is inflation,” Ulin says. “If you are blessed with longevity, consider that your cost of living may increase by 50 percent every decade and 100 percent every 20 years.”
To get a better grasp of what inflation will mean for your future income, run the numbers. If you plan to spend $60,000 a year at age 65, you may need $90,000 a year in income when you are 75 to maintain that same lifestyle.