Rules of Thumb
Retirement can be abstract. It means different things to different people. For some, it might involve a complete relocation to a warmer climate. For others, it might mean staying in place but golfing each day rather than working. And for others still, it might entail part-time work to keep active and engaged.
The amount of money needed in retirement is dependent on what retirement looks like to you. But have you ever thought about how much your retirement plans will cost? Will you need $250,000 in savings? $500,000? $2,000,000?
Trying to calculate that magic number can be difficult, especially if you are 20, 30, or 40 years away from retirement. Even when retirement is near, it’s not always easy. That’s why people turn to rules of thumb.
The chart below provides three common rules of thumb used by financial planners today. Each rule offers a simple way to estimate how much savings are needed to support a comfortable retirement. To demonstrate their usefulness, let’s introduce Sally Jones.
Sally is 67 years old, not married, and is now retiring from her job at ABC Management. Her salary last year was $100,000, and she earned a consistent 3% annual salary increase every year she worked, starting at age 25. Sally projects her expenses in the first year of retirement will be $85,000 and that Social Security will pay her $25,000 each year.
The first rule, 12x Final Salary, takes Sally’s salary in her final year of work and multiplies it by 12 to produce a savings target. The second rule, 25x Expenses, requires Sally to estimate her annual retirement expenses, reduce that figure by the amount she expects to receive from Social Security payments, and multiply the result by 25. The last rule of thumb, 15% Savings, mandates that Sally save 15% of her compensation, including company matching funds, every year of her working career.
Three rules of thumb, three different savings targets. Which one is correct?
Perhaps none of them! While rules of thumb can increase your chances of achieving a more secure retirement, they do not account for everything. Your target may vary based on the age you retire, how long you live, where you live, what you do in retirement, and how your expenses change over time.
In other words, using a rule of thumb is perfectly reasonable when you are decades from retirement. But once retirement is 10 to 15 years away, it is vital to take a closer look at your situation and really crunch the numbers. This gives you time to make any necessary adjustments before it’s too late.
So, what’s your retirement number? Have you ever calculated it? Are you on track?