If you get a sinking feeling in your stomach when you think about your retirement finances, you're not alone. In fact, 75% of Americans report feeling only somewhat confident or not confident at all about their future financial health, according to a Fidelity survey. Respondents said they worry about outliving their assets, rising healthcare and living costs, and having to adjust their lifestyle to a fixed-income budget. There is a simple way to avoid this fate and to reduce your financial stress, but few people are doing it.
Only 18% of Americans have a written retirement plan, according to Fidelity. The remaining 82% either don't think a plan is necessary or have not yet created one because they're overwhelmed and don't know where to begin. But the longer you wait to create a plan, the more difficult it is to achieve your retirement goals.
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The problem with winging your retirement
Studies have shown that when people try to estimate how much they need for retirement without creating a true plan, they're usually way off base. Gen Xers and baby boomers both said they think they'll need to save $500,000 in order to feel financially secure in retirement in a Transamerica survey, while millennials said they'd only need $400,000. But neither amount will probably be enough.
The average household headed by an adult 65 years or older spends around $46,000 per year today, according to data from the Bureau of Labor Statistics. Multiply that by the average 18-year retirement to get an average retirement cost of $828,000. Even that's likely to be too low for most working adults today because inflation will continue driving up living costs. Further, people are living longer which means retirement becomes longer too. An 18-year retirement is just the average, many folks end up spending 30 years retired. Couple that with rapidly rising medical costs and the uncertain future of Social Security and today's workers have a tough mountain to climb.
It's tempting to look for an easy, arbitrary measure to help you figure out how much you need to save for retirement, like building a $1 million nest egg or saving 15% of your salary every year. Working toward one of these goals is certainly better than having no plan at all, but it tells you nothing about your unique situation. If you want to stay on track for a comfortable retirement, you need a customized plan.
How to create a retirement plan you can count on
The first step in creating your retirement plan is to figure out approximately how many years of living expenses you'll need to cover. Estimate your life expectancy based on your lifestyle and family health history, but figure high so you're better safe than sorry. One in three 65-year-olds today will live past 90 and one in seven will live past 95. Subtract from this your ideal retirement age to estimate the length of your retirement, but be prepared to adjust that in case you determine your original plan is not feasible.
Next, add up your expected monthly living expenses in retirement. Don't include things you're paying for now, like a mortgage or childcare, if you don't expect to carry those costs into retirement. You should also bear in mind that other costs, like healthcare, may rise as you get older. Once you have your estimated monthly expenses, multiply this by 12 to get your estimated annual expenses. Then, multiply this amount by the number of years in your planned retirement, factoring in an additional 3% per year for inflation. A retirement calculator can make it simpler, but it will ask you to estimate the annual rate of return on your investments to determine how much you need to save each month to hit your ultimate goal. Use 5% or 6% to be conservative. Your investments may grow faster than this, but you can never be sure.
Your calculator should tell you the total amount you need to save overall and per month to cover your living expenses in retirement. It may also enable you to subtract any amount you expect to get from Social Security, a pension, or an employer 401(k) match, which is income you don't have to provide yourself with. If not, subtract this amount yourself to determine how much you need to save on your own. You can estimate your Social Security benefits at different ages by creating a my Social Security account.
If you cannot afford to save as much as you need to each month, adjust your plan until you find a solution that works for you. If you can't get the numbers to align with your given framework, consider delaying retirement, cutting your spending today, or boosting your income by working overtime or starting a side hustle so you have more money to save. Start saving as much as you can afford and start increasing your contributions by 1% per year until you reach your goal. You should also reevaluate your plan every few years to make sure your retirement goals haven't changed.
Planning for retirement can be overwhelming, but having a clear pathway to your goal can help. If you haven't created a retirement plan already, do so today, or consult with a financial advisor if you need assistance creating a personalized plan.
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