How Much Retirement Savings Do I Need?

How much money do you need to retire comfortably? According to a recent report from the U.S. Federal Reserve, nearly one in four Americans have no retirement plan at all. Most surprisingly, roughly one in six (17%) of adults between the ages of 45 to 59 have no retirement savings. 

Planning for retirement doesn’t have to be stressful. This guide will help you learn more about retirement planning and how you can make your financial portfolio work for you.

Assessing Your Needs

First, consider your future financial needs. What are you looking to do once you retire? Everyone’s financial goals are different, but common goals include: 

  • Paying off what remains of your mortgage
  • Handling residual debt
  • Moving into a new home
  • Travel and leisure

This list means you’ll potentially need retirement savings that not only replace your current income but offer enough to cover any hobbies or interests you take on as you reach your golden years.

Calculating Your Replacement Ratio

One of the most useful tools in calculating your retirement savings is known as the “replacement ratio.” Your replacement ratio will help you determine how much money you’ll need after you retire. 

To calculate your replacement ratio, simply do the following: 

  • Add up your anticipated (post-retirement) monthly expenses
  • Multiply these expenses by 12 (to get your yearly needs)
  • Divide your yearly expenses by your current income 

For example, if you currently make $100,000 per year and expect to need $70,000 once you retire, your replacement ratio is 70%. 

Most experts suggest a replacement ratio between 70% and 80%, though this depends on your life expectancy and lifestyle goals. This replacement ratio serves as an important benchmark as you work your way toward retirement.

How Much to Save for Retirement Each Year

Your replacement ratio can help you live within your means once you retire, but putting enough savings away can feel a bit daunting. 

Financial experts recommend saving as much as 15% of your income each year for retirement. The exact amount can vary by age, and the closer you get to retirement, the more you’ll want to ensure that you have enough savings. 

Here’s a good rule of thumb: by the time you turn 30, you should at least have your annual salary put away for retirement.

How to Convert Your Portfolio to a Retirement Account

Before retirement, you receive a paycheck from your employer. Once you retire, where do these “paychecks” come from? 

Retirees can typically count on Social Security or pension payments to fund their later years. But your retirement portfolio now becomes your paycheck. You can withdraw money from your portfolio to cover your monthly needs based on the same calculations as above. 

Here’s how to convert your retirement portfolio into a paycheck:

1. Assess the Value of Your Portfolio

At the beginning of the year, calculate the total value of your portfolio. For example, imagine that your retirement portfolio is $1.0 million at the start of the year. This number will help us calculate how much to withdraw.

2. Establish Financial Guardrails

Once you evaluate your portfolio, you’ll want to establish financial “guardrails.” These are upper and lower limits that influence how you interact with your portfolio. In this example, the upper guardrail is $1.25 million, and the lower guardrail is $840,000.

3. Calculate Your Withdrawal Rate

Next, calculate your withdrawal rate. Most retirees should aim at a withdrawal rate of 4% to 6% of the total value of the portfolio. If we stick to the same example, 5% of the $1.0 million portfolio yields an annual withdrawal of $50,000. 

Remember, you only need enough money to supplement your Social Security and pension, so don’t worry if the initial withdrawal amount seems limiting.

4. Evaluate Your Portfolio Annually

It’s important to evaluate your portfolio annually. If you stayed within your guardrails and got a positive return in the market, you give yourself a raise for inflation. This approach ensures you retain your purchasing power even if consumer prices rise. 

What if you received a negative return? Don’t worry about it. You can still have the same paycheck, just no raise. This approach ensures that you maintain the same principal value.

5. Adjust Your Income

Adjustments are why the guardrails are so important. If you exceed the upper guardrail during the year, you can increase your withdrawal rate by as much as 10%. Likewise, if you dip below the lower guardrail, try to scale back as much as possible to preserve your principal. 

Either way, you’ll want to reset the guardrails every time you make a change in your withdrawal rate. Remember: if you go too far outside these guardrails, your portfolio can’t handle your withdrawal rates, and you can run out of money.

6. How Much Do You Need?

Finally, how much retirement savings do you need? The answer is that it is an iterative process and depends on how much you plan on spending. Sticking to the same example, if you need $50,000 a year to live on in retirement, you will need approximately $1.0 million in retirement savings.

Don’t forget to account for social security and pension income. If you receive $10,000 a year in social security and or pension income, then you would need approximately $800,000 in retirement savings (assuming the same $50,000 in annual expenses).

The Benefits of an Ongoing Paycheck

This “portfolio paycheck” approach can provide a lot more money than you might imagine. Additionally, this process can help you respond to emergencies more readily since you retain so much of your principal value. 

The process only works if you review and update your plan annually, but doing so provides peace of mind that you will have a regular paycheck well into your retirement years.