Fact: one-third of Americans age 55 and above don’t have a retirement nest egg. This is according to a 2018 study by the Government Accountability Office. Those who don’t have retirement income don’t have enough money to spend on their post-work years. And come to think of it, it’s scary.
These sad numbers can be rooted in the Americans’ lack of financial understanding and education, according to TransAmerica. Two-thirds of workers said they have little to no idea about asset allocation and how their retirement money is invested. Only a meager 29% of 60-year-old Americans said they know “a great deal” about Social Security.
This is the sad truth about retirement in the US. However, it doesn’t have to remain that way.
It is a must to learn these things early on your works years to secure your future. And one great way to start is by learning how much income you need to retire.
Below, we’ll discuss all you need to know about computing the ideal retirement nest egg. Find out how much the average Americans are making in terms of the traditional retirement plans, 401(k) and IRA. Also, discover how much you’ll need to live a comfortable retirement life, as well as ways to meet your retirement income goals.
The Average Income You Need to Retire
When planning your retirement, one crucial question that you need to answer is, “How much does the average person need to retire?”
Based on research from Schwab Retirement Plan Services, Americans believe they need $1.7 million to retire.
However, the answer to this question still varies per individual. The “average” amount may apply to some and may not for you. This is because you might be envisioning a completely different lifestyle than that of the average Americans, say, a more luxurious or comfortable life upon retirement.
This is why it’s crucial to consider several factors that play a role in determining how much you should save for your retirement nest egg. This includes your current income, your future expenses, and the lifestyle you want after retirement.
Below, we listed down three steps to compute for the average income you need to retire.
3 Steps to Determine Retirement Income
Step 1: Estimate your retirement expenses
The first step to determine how much retirement income you need is to have an estimate of your monthly spending. To begin, get the sum of all of your inevitable expenses. These include housing, transportation, healthcare, food, and personal insurance expenses.
Then, identify any discretionary expenses such as travel, hobbies, and entertainment. Assuming that you’re free of debts upon retirement, get the total of your inevitable and discretionary expenses.
The Different Phases of Retirement
It is also worth noting that your expenses may change as you reach different phases of retirement. Many retirees reported to have experienced three distinct phases of retirement, which we discussed below:
- Higher spending early on
- In their first few years of retirement, many retirees reported that they would spend more than what they would spend while working. This is because they now have more time to go out and spend their money.
- A massive chunk of their retirement income is also spent on home-related expenses. Bills like rent payments, utilities, and maintenance eat a big slice of the retirement income pie. Some retirees even end up moving to new homes that would cost them more than their previous house.
- Modest spending for an extended period after that
- As you grow older, you’ll be spending less and less on travel, hobbies, and entertainment. And it’s not a bad thing. This means you’ll have fewer expenses to worry about, and you’ll be able to focus on your living costs.
- Higher spending on end-of-life care
- In the last phase of retirement, expect to experience higher spending. Healthcare expenses are inevitable in every retiree’s remaining years. This is especially true when you’re nearing the end of life. As you age, you’ll be needing to spend on medical and long-term care expenses more frequently.
Average Retiree Spending According to BLS
Based on data from the Bureau of Labor Statistics, retirees from older households spend an average of $3,800 monthly. Older households include those retirees who are 65 and older.
The same research broke down average monthly retiree spending by several categories:
- Housing: $1,322
- Transportation: $567
- Healthcare: $499
- Food: $483
- Personal Insurance or Pensions: $237
- Charitable Donations: $202
- Entertainment: $197
Alternatively, experts also suggest the use of Rule of 80 to find out a rough guess of your expenses.
Understanding the Rule of 80
The Rule of 80 determines how much retirement income you’ll need annually. In this rule, you have to save 80% of your annual pre-retirement salary. This means that if you’re making $100,000 every year, you’ll need at least $80,000 to live the lifestyle you have while you’re still working.
The Rule of 80 excludes major expenses that will be gone upon retirement. This includes transportation costs, entertainment costs, and retirement plan contributions, to name a few. It makes sense since you won’t probably be commuting every day during your retirement.
However, if you’re factoring out significant expenses, you also have to take in new expenses that come with retirement. For instance, you might be planning to go on frequent travels in your early retirement years. Meanwhile, you also have to consider healthcare expenses as you grow older.
Step 2: Calculate how much you need to retire
After identifying your estimated monthly expenses, it’s time to determine how much you need to save.
To compute your average retirement income, multiply your monthly expenses by 12. For instance, the average monthly expenditure of retirees in America is $3,800. In a year, that’s $45,600.
Then, apply the 4% rule of retirement.
Understanding the 4% Rule of Retirement
This rule of thumb states that you should withdraw 4% from your retirement income each year. The 4% rule of retirement determines how much you should spend each year to live a comfortable life. It was created to maintain your account balance and keep income flowing in your retirement.
Going back to the example above, if an average American spends $45,600 annually on expenses, divide it by 4%. That’s $45,600 / 0.04, which is equal to $1,140,000. That’s the safe amount you should save on retirement.
Likewise, if you’re estimated amount is $80,000 annually, you should save $2,000,000 for your retirement nest egg.
Experts believe that the 4% rule of retirement is a safe amount for retirees. In a study by financial advisor William Bengen, he found out that no historical case exhausted a retirement portfolio of 4% in less than 33 years. That’s amidst the market downturns in the 1930s and 1970s.
However, keep in mind that you should stick with this amount every year. Spending more on major purchases, even in a single year, can have adverse effects in the later phases of retirement. This is because it reduces your principal, and it directly affects your portfolio.
Step 3: Work towards your retirement goal
Now that you have made a reasonable estimate, it’s time to work on your retirement nest egg. One great way to do this is to build your retirement accounts like 401(k) and IRA early in your working years.
The Average 401(k) Balance
The 401(k) plan is the most popular type of employer-sponsored retirement savings in the US. In this plan, you invest a portion of your salary into long-term investments. Then, your company offers a match to your contribution up to a limit.
According to Fidelity Investments, the average 401(k) balance is $103,700. However, account balances still vary by generation.
Below is a breakdown of average 401(k) plans of Americans as of the first quarter of 2019, including the contribution rates.
- 20 to 29: $11,800 (7%)
- 30 to 39: $42,400 (7.8%)
- 40 to 49: $102,700 (8,5%)
- 50 to 59: $174,100 (10.1%)
- 60 to 69: $195,000 (11.2%)
Starting in 2020, the maximum amount an individual can contribute to 401(k) annually is $19,500. And with the joint contribution of both employer and employee, you can save up to $57,000 yearly.
The Average IRA Balance
An individual retirement account (IRA) is an investing tool to build one’s retirement nest egg. There are different kinds of IRAs, and then you need to depend on your employment status. Individual taxpayers like you invest in traditional and Roth IRAs.
Traditional and Roth IRAs differ from the way they are taxed. In the traditional IRA, you get taxed for your contribution and pay income tax, whereas in Roth IRA, withdrawing money is tax-free.
Since IRAs are an investment, the amount you earn depends on the interest rate of the investment you’ll choose. Remember that not all accounts are created equally.
For instance, a traditional bank has a lower return rate than that of bonds, exchange-traded funds (ETFs), index funds, and stocks. And just like any investment, the higher the risk, the higher the return is.
Here’s an example: if you contribute $6,000 per year at a 7% interest rate, you’ll have over $500,000 after 30 years. You can use an online calculator to get an estimate of your possible IRA returns.
In 2020, you can contribute up to $6,000 traditional IRA annually if you’re below 50 years old. When you reach 70 ½ years old, you’re not qualified to contribute anymore.
Just like the traditional IRA, Roth IRA allows you to contribute $6,000 if you’re under 50. But to qualify for this investment, your salary should not exceed $124,000 for single individuals and $196,000 for married couples.
The 401(k) and IRA combined may not be enough
The 401(k) and IRA can get you off to a good start saving up. However, these retirement plans can only do so much. That’s why you need to take other measures to boost your retirement income.
You can also get more tips and use our Retirement Calculator to help you determine where you are and where you need to be for retirement.
How to Save for Retirement?
Aside from the Rule of 80 we discussed above, you may also opt to try Fidelity’s tips to build your retirement nest egg.
If you want to retire by age 67, Fidelity suggests a concrete timeline to meet your retirement income goals. The concept is to have eight to 10 times your final salary in savings starting from your pre-30s.
- By age 30: Save half of your annual salary
- By age 40: Save twice your annual salary
- By age 50: Save four times your annual salary
- By age 60: Save six times your annual salary
- By age 67: Save eight times your annual salary
Going back to the example above, if you’re earning $100,000 annually, you should save at least $50,000 by the time you reach 30. By age 67, you should be able to save at least $400,000.
But $400,000 plus the average 401(k) and IRA may not be enough to reach your goal, say, the $2,000,000 retirement mark. If this is the case, it’s time to learn some ways to boost your retirement income.
Ways to Increase Your Retirement Income
Don’t just depend on your 401(k) and IRA to fund your life after you leave the workforce. Seek more ways outside the traditional retirement plans to sustain your needs come retirement day. Below we listed down some smart financial moves to secure your future.
Wait before filing Social Security
As of September 2019, retirees can get an average of $1,474.77 Social Security benefits every month. While this may not be a considerable amount, you can increase it with enough patience.
To boost your Social Security benefit, hold off claiming it until past your full retirement age. Your full retirement age should be around 66-68. Claiming until you’re 70 allows you to enjoy an additional 8% annually. This means you’ll be receiving $3,790 per month.
This tip is great if you’ll be retiring in good health. You’ll have plenty more time to bump your Social Security benefit.
Build your investments portfolio
Take advantage of investment opportunities while you’re still young. During your early work years, experts advise you to focus on growth stocks. These include investments that increase in value over the years.
But as you approach your retirement years, you should switch to interest-generating assets. You have plenty of options to choose from, such as bonds, dividend income funds, and real estate investment trusts (REITs).
Take on part-time jobs
Post-career works won’t only get you more bucks during your retirement years, but it will also give you a sense of purpose. It will also allow you to socialize, which you’ll need when you’re already retired.
Choose a job that you’ll enjoy so you won’t feel like working. Consider your hobbies and passion for making a few bucks.
However, keep in mind that working in your retirement could impact your Social Security benefits if you claim it before full retirement age.
Start a small business
Landing a regular job may be hard and unappealing for future seniors like you. If part-time work is not your thing, then you should consider running a small business.
A home business is flexible and can be run part-time. This means you’ll still have plenty of time to enjoy your retirement days.
Like part-time jobs, you can turn your hobby into an income-generating activity. Offer your services like blogging, gardening, or bookkeeping to make extra cash. You can also sell used and unwanted items online, that is, if it’s still a trend some 40 to 50 years from now.
Consider a reverse mortgage
A reverse mortgage allows you to get a loan from a lender. What you need to do is to make your home as the collateral.
The great thing about this method is that you don’t have to pay the loan until you’re not living in your home anymore. This is a viable option if you need cash and don’t have anyone inheriting the house.
Borrow from your life insurance
If you bought permanent insurance like the universal life or whole life, consider borrowing against it. You’ll get paid handsomely, and the best thing about it is that the income is usually tax-free.
But this trick is only feasible if you’re confident that you won’t be needing the ultimate payout. This means you don’t have children that will be depending on it.
Reduce your expenses
Finally, reduce your planned retirement expenses. When creating a retirement plan, adjust your expenses as you near the retirement years. There are several ways to do this, including downsizing your home and your lifestyle.
One of the best ways to cut off your future spending is to take care of your health now. Healthcare costs are expected to skyrocket to $285,000, according to CNBC. To prevent spending a large portion of your retirement nest egg in future medical bills, observe an active lifestyle now that will improve your health.
Also, paying high-interest debts and mortgages should be a priority. These include personal loans, credit cards, and housing expenses.
With these financial moves, you’re sure to save more that you can add to your usual 401(k) and IRA. This gets you closer to achieving your retirement nest egg goals.
Getting started early on building your retirement fund is a must. That is if you don’t want to end up like the two-thirds of Americans who struggle to live their retirement lives without a nest egg.
Follow the steps above to determine how much retirement income you’ll need to come the time you leave the workforce. Learn from the average 401(k), and IRA senior Americans now have, and then, plan yours wisely.
Also, consider the tips above to earn extra to achieve your desired retirement fund amount. And begin doing it now, not later.