“The Number” — or the amount you need to save during your working years in order to have a comfortable retirement — is, in my opinion, the Holy Grail of personal financial planning.
Some of the most skilled financial professionals that I know struggle with this concept. Just how much money do I really need to retire?
I personally have been a student of this notion of “The Number” for the better part of my professional career. There have been books written about it, theories published, and a myriad of opinions given by experts in the field.
With so many views on this idea, I thought I would try and simplify some of the fundamental questions surrounding this somewhat abstract concept.
What Does The Number Have To Cover?
Basically, “The Number” has to cover your overall living expenses during your retirement years. Maybe a better question is what your standard of living is going to be in retirement. You may be wanting to take exotic vacations, buy a cabin in the woods, take a cruise every month (my vote goes here), become a generous donor to charities, or just maintain your current lifestyle.
If you still have debt, such as a house or car payment at retirement, you will need to allow for those monthly payments in your planning. You may decide to downsize at retirement in order to reduce your debt. You could move to a more affordable location as well. So there are several factors to take into account as you look at what the number has to cover.
How Do You Calculate The Number?
So here is the question that has so many of us perplexed. While there certainly is not a lack of professional opinions in answering this question, I will just give you one basic approach that I like to use in calculating the number.
After you have answered my first question of what you need to cover in order to maintain the lifestyle you want in retirement, you should be able to come up with a monthly dollar amount. For example, let’s say your house will be paid off, and you determine that you will need $4,500 per month to meet your on-going living, housing, medical, and travel expenses in retirement.
Finally, annualize the monthly amount you calculated and multiply that amount by 20 to arrive at the number. In our on-going example, you will take the $2,700 net monthly amount and multiply that by 12 to arrive at the annualized amount needed of $32,400. That annual amount multiplied by 20 equals $648,000. Now you have The Number!
This is the amount that you will need to accumulate over your working career in order to retire comfortably. This is an estimate, which means that a lot of things can change along the way, but at least you have a target.
How Do You Save To Get To The Number?
One of the best ways to save for retirement is to take advantage of an employer’s 401K retirement plan. I would also suggest that you consider using a Roth election inside the 401K, as most employer’s plans allow for this. The Roth election allows you to take the funds at retirement tax free. The tradeoff being that you pay the taxes now on your retirement contributions.
The benefit of a 401K is that the funds are automatically deducted out of your paychecks and deposited into the plan for you. Also, in most plans of larger employers, you will get a match on your contribution. That just means that the employer will add to the amount you elect to have deducted. Sometimes that match can be as much as 100% which will double your contribution amount.
If you don’t have a 401K at your work or you are self-employed, you can still use an Individual Retirement Account (IRA) to save up the number. The Roth election works with this type of account as well.
So back to our example. Using an on-line financial calculator with an ultra-conservative investment return of just 5%, I determined that you would need to save $200 per biweekly paycheck over a 40-year career. This amount works with either the Roth 401K or the Roth IRA. If your employer happens to match contributions in a 401K plan, that amount goes down. Let’s say our employer matches dollar for dollar. Our deduction now goes down to $100 per paycheck!
While there are much more sophisticated methods to calculate the number, I have provided a simple approach that helps you to at least develop a savings goal. The sooner you start, the better the possible outcome for your retirement. As I tell my students, having more time to save can beat some of the best investment advice out there. So, go start building your number!
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David W Clark, MPA, CPA
Instructor of Accounting & Healthcare Management