Rule of Thumb Method
One common rule of thumb states that you will need about 80% of your pre-retirement income during retirement. So, if you are earning $50,000 a year just before you retire, you can estimate that you’ll need around $40,000 of income in retirement.
The reason this rule states you’ll need less income when you retire is that you’ll probably have fewer expenses in retirement. This rule assumes you may no longer have a mortgage, no dependents living at home to support, and no longer be putting money aside to save for retirement. As you can see, these are pretty broad assumptions.
While the 80% rule of thumb may give you a quick estimate, it’s far from perfect. For some people, they may actually need even more money in retirement depending on what they plan on doing. Some may be looking to buy a new house, do extensive traveling, or may be faced with a medical condition that significantly increases health care expenses.
Detailed Expense Method
The rule of thumb might be a good starting point for younger people, but as you approach retirement it is important to take a serious look at how much money you’ll really need. The best way to estimate how much money you’ll need is by looking at your expected income expenses in retirement.
First, identify your retirement income sources. What is your estimate Social Security benefit? Will you be receiving a pension? And how much will you have saved for retirement? Then, think about what your expenses will look like. Will you still be paying off your mortgage in retirement? Will you be moving or making any large purchases? What is your life expectancy and how long does your money need to last? And then don’t forget to account for inflation.
Once you start to tally up your monthly expenses in retirement, even if they are just estimates for now will help you begin to see how much money you’ll need to have to cover these expenses. You may find it’s much less than expected, or it could be even more than expected. From there you can consider what your projected retirement income will be and see how much of a surplus or deficit you have.
What to do When You Don't Have Enough
If it looks like you haven't saved enough yet, it's time to start planning now to begin making changes. It doesn't matter if you're 30 years from retirement or just a few years -- taking action can lead to improvements in retirement.
If you still have a few years until retirement, consider beefing up your 401(k) plan or IRA contributions. The longer your money has to grow, the better off you'll be. Compound interest is a wonderful thing, so don't let time pass you by.
For those who may already be ready to retire, the added savings might not be as effective. It can help, but you may find it is better to delay retirement a little or delay Social Security. You might be surprised at how much another year or two of work can help your situation. It might not be ideal, but when you factor in the money earned plus potential benefits such as health insurance, it could be more than worth it.