I just hit a milestone birthday and am officially a 30-year old. My 20s—a decade where life mistakes are more forgivable and there is a lot of time to recover from financial mistakes—are behind me and my husband. As a regular reader, you know that I take finances and particularly retirement savings very seriously. However, after automating our retirement savings and investment allotments, I haven’t paid much attention to the bigger picture in terms of projecting our current savings with the amount we will save each year and figuring out at what age this will allow us to retire (and then adjusting accordingly).
Our Current Retirement Picture
Paul and I each have Roth IRAs that we max out every year. On top of this, Paul has a lingering 401(K) that he cannot contribute to as of two years ago when his company was bought out (which needs to be consolidated into his Roth IRA). I also have a pension at my job that I will be fully vested in after five years of service on December 15, 2012 (if I leave before then, I will not be vested in it at all but I would get my own contributions to roll into my Roth IRA). Overall, we are saving 14.5% of our income towards retirement each month. This sounds great, but how much will we accumulate over time, and how much will we need to accumulate over time in order to retire?
Several Options to Come Up with Our “Number”
Even though Smartmoney.com suggests that having a “number” in mind at which retirement can be achieved is not necessary, I think figuring out an estimate will give us something to shoot for. At this point, we truly have no idea how much we will need in an account before being able to retire. There are many different methods and projections used to come up with the “number”, some of which overlap. I’ve narrowed it down to two below, and then came up with a hybrid approach.
- The 75% Replacement Rule: If you wish to figure out how much money you need in retirement using a percentage of your pre-retirement income as a gauge, experts state that it is between 70-95% depending on your situation. I used T. Rowe Price’s Calculator, which assumes a 75% replacement rate of our pre-retirement income, to determine that if we continue saving 14.5% of our income each month until the age of 65, then we will have $7,200 in monthly income (includes income from social security, pension and our IRAs). This does not give a large number to shoot for, but rather a monthly income figure to shoot for.
- The 4% Number: Assuming that you stay invested in the market with a balanced asset allocation (evenly split between large-company stocks and U.S. Treasury bonds) then you can use the 4% rule. According to this rule, in order to have enough retirement income to last you for 30 years you should set aside enough savings and investments that you can withdraw 4% from the first year (adjusted annually for inflation). You can figure out the overall amount you will need, the annual income you wish to sustain during retirement, or both using the 4% rule. For example, if you have $1,000,0000 invested in the market, then you can withdraw an income of roughly $40,000 per year for roughly 30 years. On the flipside, if you want an annual salary of $60,000, then you know you will roughly need $1.5 million in investments by the time you retire (4% of $1.5 is $60,000, or $5,000 per month).
- A Hybrid Approach: In order to achieve the 75% in pre-retirement income from the replacement rule above, and in order to withdraw only 4% annually from our investments to ensure that they last us roughly 30 years into retirement, we would need to have investments of $2 million before entering retirement (forgive me while I pull myself back up from the floor!).
Choosing Our Ultimate Number: Lots of Variables Involved
Aside from different calculation methods with varying outcomes, there are other variables involved when planning for retirement. These include whether or not you will have a mortgage, having children early on in life versus late in life when they could be in college around your age of retirement, medical conditions/life expectancy, unforeseen events, investment returns, whether or not you plan on working part-time at a hobby or passion job, inheritances, what age you want to take Social Security, lifestyle inflation, etc.
My husband and I plan on having our mortgage paid off before retirement (we refinanced to a 15-year mortgage earlier this year), but are unsure of kid(s). I also know that we are the type to probably earn some kind of money in retirement as a hobby/passion (like Frugal Confessions!). While we are frugal, we do love to travel, so the two may cross each other out in our retirement years.
Given the calculations above and all of the variables involved, I think that it is definitely possible that we will not need 75% of our pre-retirement income to live comfortably, but that we will live close to 30 years into retirement. We will continue saving the 14.5% per month in retirement, look into opening a 401(K) to save more money in, and shoot for $1.5 million+ in investments 35 years from now. With a conservative investment return rate of 4%, I plugged this number into a calculator and found that we need to save $1,344.00 per month in order to reach the $1.5 million goal 35 years from now. We’ve got something to shoot for!
Have you figured out “your number” for retirement?