Imagine running a long-distance race, but you don’t know how far you have to run. How do you pace yourself? How do you strike the right balance between running fast enough to win, but not so fast that you run out of gas before you reach the finish line?
This is the issue we face when thinking about retirement. How can we know how much we’ll need to retire when we don’t know how many years retirement will last? How do you balance today’s needs with an unknown future? What is enough to ensure our comfort during retirement when we don’t know what our needs will be as we age?
If the thought of saving enough for retirement stresses you out, here are five principles to follow:
1. The 80% Rule
When it comes to evaluating how much you’ll need to retire, don’t just think in terms of an overall dollar amount. Think in terms of income. This is where the 80% rule comes into play.
If you want to maintain your pre-retirement lifestyle throughout retirement, your monthly income from sources like Social Security, pension, and savings withdrawals will need to add up to 80% of your working income.
2. The 4% Rule
The median life expectancy in the U.S. is 78.6 years (Arias E, 2017). If you’re married, there’s a 45% chance one of you will live to 90 (Retirement Plans Executive Committee, 2014). With such long-life expectancies, it’s more important than ever to plan for retirement early and prepare for a long retirement. Following the 4% rule will ensure that your nest egg will last.
If you withdraw only 4% of your savings in the first year of your retirement and adjust that amount each year to account for inflation, your savings should last about 30 years.
If you retire at 67, the 4% rule will fund you well into your nineties. Combined with the 80% rule, you should be able to maintain your quality of life throughout your retirement.
3. Account for Inflation
Whatever dollar amount you currently think you’ll need at retirement, it’s probably not enough. Why? Because it’s important to take inflation into account. It’s not enough to think of the dollar amount you need each year and multiply it out for thirty years because living will get more expensive over time.
To protect your retirement, assume a 3% annual rate of inflation. If you think you’ll need $1 million to retire, you’ll actually need closer to $2 million to account for the increased cost of goods and services over time.
4. Debt-free Retirement
There will be a lot less pressure on your retirement savings if you’re debt-free when you leave the working world behind. Imagine how much more money you’ll have each month if you don’t have to worry about a mortgage, car payments, credit card debt or student loans. Create a plan with your financial advisor to be debt-free before retirement and lessen the burden on your retirement accounts.
5. Prepare for the Unexpected
Following the four principles above ensures that you’ll be prepared for a comfortable retirement, but those funds can dwindle quickly if tragedy strikes. If you face a chronic or critical condition during your retirement, you may not have the funds to cope with medical bills and keep up your standard of living. Disability can limit your mobility and require long-term care that gets expensive quickly. Protecting your retirement investment means preparing for the unexpected. A life insurance policy that offers living benefits can offset the costs of care while you’re alive so that you can maintain your quality of life.
If thinking about retirement savings is stressful, you’re not alone. But it doesn’t have to be overwhelming. The first step to creating a workable savings plan is to understand exactly how much you’ll need in savings when the time comes to put your work life behind you