While it's good to focus your retirement planning efforts on simply saving up as much as you can, you should also have an idea of what is a good goal. But with so many variables, how can you know what that target should be?
Here are a few methods for doing so. Find the right one by understanding how they each work.
The percentage method takes your retirement savings and multiplies it by a certain percentage that you could take out each year. Traditional retirement planning bases this method on removing 4% of the total balance per year for your expenses. By multiplying 4% by your savings amount, you'll know how many years your retirement savings will last and how much money you could take out each year.
Some financial planners doubt the usefulness of the 4% amount, feeling that it is too much to maintain a reliable retirement account. You should consult with a professional before using this as your guideline.
Current Income Method
Another way to approach retirement income is to look at your current income and estimate future needs based on it. Many experts feel that you should expect to need about 70% to 80% of what you currently earn. Some expenses will be lower during retirement—particularly those related to work and retirement contributions—while others may be higher, like travel and entertainment.
This leads many financial planning professionals to consider 70% to 80% of your current income to be a relatively accurate expectation for your later needs.
Current Spending Method
The problem with using the current income method is that a number of things could overestimate your needs or underestimate them. Your current income, for instance, should include retirement savings, work-related expenses, income taxes, and expenses related to caring for others, usually children or aging parents. Many of these expenses won't be relevant to your retirement expenses.
You could, then, base your expectations not on your income but on what you actually spend. Break down current spending into categories like housing, taxes, savings, food, transportation, and professional costs. You can rule out certain categories or plan to lower them, and then you'll have a more accurate amount that you need in retirement each month.
No matter which of these retirement calculation methods you opt for, making the effort to identify your retirement target will be worth the effort. You'll be doing something that few Americans actually do, and you'll surely have a more secure future because of it.