If you're looking for a retirement savings goal, you might need a slight shift in your approach to get the best possible outcome. A few established rules can help you determine how much money you need to comfortably exit the workforce. Use these rules to craft a successful strategy that's tailored to your circumstances.
Personal circumstances play a huge role
Many people want a magic number for ambitious savings goal setting. It's intuitive to monitor an account balance to figure out if you're meeting key milestones. Balances are a convenient scoreboard.
That's a flawed approach in most cases. Financial planners have no consensus on the magic number. Retirement goals and cash flow resources can vary dramatically among households. The cost of living can be significantly higher in some places, changing the baseline requirements to make ends meet.
People with more substantive Social Security benefits might shoulder less personal burden than others. Retirees with defined benefit pensions similarly have different savings requirements. Lifestyle expectations are also very different from person to person, so there aren't even uniform financial requirements for retirees. These variables make it impossible to identify one target amount that's a valuable guideline for everyone.
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Fortunately, there are several widely accepted methods you can use to reliably estimate the amount of assets you'll need to meet your personal retirement goals. This takes a few extra steps and effort, but it's a helpful exercise for creating a plan with measurable progress.
Estimating your cash flow needs
Cash flows are just as important as assets in retirement planning. Your baseline requirement is ultimately to replace the earned income that's lost when you leave the workforce. Once you understand your cash needs, you can estimate the money necessary to meet those needs.
Three different retirement savings rules can help you bridge that gap:
- You need to replace roughly 80% of your pre-retirement income to have a seamless transition into post-working life.
- Your savings should equal at least 10x your annual income at retirement.
- According to the 4% Rule, you can safely distribute 4% of your retirement account each year without exhausting your financial resources prematurely.
These are three different ways to think about solving the same problem: How can you ensure that you can meet your needs without outliving your money? The first step to using the above rules is determining your cash needs. If you are comfortable living with the bare minimum necessities, then you'll need to clear the Federal poverty line by around $20,000 for a household of two people.
People often maintain more ambitious financial goals, so most households will have higher cash needs. Median household income is around $80,000 for pre-retirees right now, so the average couple entering retirement would need around $65,000 in annual income to seamlessly maintain their lifestyle, according to the first rule above. More affluent households would need even more cash to avoid a lifestyle change.
After figuring out how much cash flow you'll need, you can identify income sources that offset the burden on your investments. Most people are entitled to Social Security retirement benefits. The average benefit is around $21,600 annually, though some people can expect nearly $60,000 from the system each year. If you have a defined benefit pension, then you have guaranteed income through that plan.
After subtracting these and any other sources of retirement income, you are left with the gap that needs to be covered with distributions from retirement savings. This is the step at which the second and third rules listed above become important.
Consider a hypothetical household with the median $80,000 of income before retirement, and assume that they expect to receive the average $1,800 monthly Social Security benefit. The second rule indicates that this household would need $800,000 to $1 million to seamlessly maintain its standard of living in retirement. The 4% Rule suggests that the same household would need $1.06 million saved. That's assuming they have the first $21,600 covered by Social Security, meaning that they need another $42,400 of annual distributions from retirement accounts to equal 80% of pre-retirement income.
As you can see, the three rules above might result in slightly different savings targets, but they will help you confidently estimate an approximate figure. This process is backed up by decades of observations on millions of people. Everyone's circumstances are different, but $250,000 should represent the low end of your asset-building goals. Most households should strive for $1 million to comfortably maintain their lifestyle without running into excessive longevity risk.
