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Your Retirement Planning Guide For Right Now

The earlier you start retirement planning, the better chance you have of retiring the way you want. That’s true whether you are 25 years old or 50. So the best time to kick off a retirement plan is always right away — because yesterday isn’t an option.

There are many questions as you work through the retirement planning process. A big one is: How much savings do I need to retire? Let’s walk through how to answer that question to help create a solid plan for reaching your goal.

1. Decide How Much Income You’ll Need in Retirement

To understand your target retirement savings, you first must know how much income you’ll need in retirement. The simplest way to estimate your target income is to adjust your current living expenses according to any changes you expect in retirement. Some common changes to consider are:

  • Paying off your mortgage or other debts.
  • Relocating or downsizing.
  • No longer paying FICA taxes, which are only charged on earned income. For most people, the FICA tax rate is 7.65%. Withdrawals from your 401(k) and traditional IRAs will incur ordinary income taxes, but not FICA taxes. Your Social Security income is likely taxable, too.
  • Elimination of retirement account contributions.
  • Lower transportation costs if you will no longer commute to work.
  • Higher transportation costs if you plan to travel in retirement.
  • Transitioning off employer-sponsored healthcare to a Medicare plan. For context, a report from the Center for Retirement Research at Boston College concludes that the median retiree spent about $4,300 on out-of-pocket healthcare expenses in 2018.

Most of these changes will lower your living expenses in retirement. This is why financial advisors often recommend planning for a retirement budget that’s 80% of your working income. If you make $80,000 today, for example, your target retirement income would be $64,000.

You could jump right to that easy 80% calculation, but resist that urge. This target income number drives the rest of your retirement plan, and you want it to be as accurate as possible. For a better end result, take the time to crunch your own numbers.

2. Check Your Expected Social Security

Social Security produces, on average, about $20,000 annually in retirement income. If you and your spouse qualify for a federal retirement benefit, you could earn $40,000 a year or more as a couple. That’s a sizable number, one that should not be overlooked in your retirement plan.

To estimate your retirement benefit at any age, create an account at my Social Security. Once you log in, you’ll see your current benefit estimates at different claiming ages. When you claim at a younger age, your benefit is lower. Delay your benefits and the income is higher.

Social Security’s benefit estimator assumes you will continue earning your current salary until you retire. You can adjust this number and recast your benefit estimates. You may not want to, though — even if you get a raise every year.

Your annual raises are only significant in this calculation if they outpace inflation. If you expect to earn salary increases that track with inflation, it’s correct to assume your salary will remain flat until you retire. In this scenario, the dollar amount of your income may rise, but your purchasing power will stay the same. Since your benefit estimates are in today’s dollars, they’re only accurate if you keep the salary estimates in today’s dollars, too.

Accounting for Future Changes to Social Security

There’s one more tricky part about estimating your retirement benefit. The latest projections from the Social Security and Medicare Boards of Trustees show a funding shortfall on the horizon. That shortfall may affect benefits starting in the mid-2030s. Should these projections prove to be accurate and legislators don’t implement a fix, Social Security recipients could see their benefits dip by about 20%.

That outcome would be disastrous for the millions of seniors whose federal retirement benefit is their primary income source. So it’s hard to imagine legislators would let that happen. Still, you need your retirement plan to be conservative and realistic. In that vein, you might discount your expected benefit by 15% or 20% — just in case.

3. Set a Retirement Savings Goal

Once you know your target retirement income and expected Social Security, you can estimate the income you need from your savings. Say you’re targeting $64,000 in total annual retirement income. And you’ve conservatively projected your federal retirement benefit at $20,000. That leaves a gap of $44,000 that you’ll fill with income from savings.

You can turn that $44,000 income target into a savings target with a quick calculation. Simply divide your income target by 0.04. This number, 4%, is a safe withdrawal rate from your retirement account. When you divide your target income by 4%, you are calculating the savings that would support that withdrawal rate. In our example, you’d need $1.1 million on hand to withdraw $44,000 annually.

Depending on your investing approach, it may be appropriate to adjust that 4% withdrawal rate up or down. Doing so would change your target savings balance. This is a conversation to have with a financial advisor, who can recommend an appropriate withdrawal rate for your situation.

4. Make a Retirement Investing Plan

The heart of your retirement plan defines how you’ll save and invest to amass the money you need. If you don’t have a financial advisor or investment specialist to guide you, you’ll want to get comfortable using a compound interest calculator or savings goal calculator like this one. Given the right variables, the calculator estimates the monthly investment needed to reach your goal.

Estimating Your Investment Growth Rate

All compound interest calculators will ask you to provide an expected growth rate. This is tricky, because you can’t predict how the stock market will behave over the next year or even five years. If your timeline is 10 years or more, though, you can rely on the market’s longer-term average growth rate, net of inflation. That rate is about 7%.

You can expect to earn around 7% annually on average if:

  • You plan to invest primarily in low-fee equity index funds.
  • You are investing in tax-advantaged retirement accounts, such as a traditional IRA, Roth IRA, or 401(k). These accounts defer your annual taxes on interest, dividends, and capital gains earned.
  • Your account fees in the IRA or 401(k) are minimal.

If your investment approach has a moderate-to-heavy exposure to bonds vs. equity, though, you’d expect a lower growth rate. The same is true if your index or mutual funds and/or your 401(k) charges 1% or more in fees annually.

Estimating Your Monthly Investment

Here’s a scenario to walk through how you’d estimate the monthly investment needed to reach your savings goal. Let’s say:

  • You have 30 years until your scheduled retirement date.
  • You’re investing in a 401(k) with low-fee funds.
  • Because you have a long timeline, you decide to invest aggressively. Your target portfolio composition is 90% in an S&P 500 index fund and 10% in a U.S. Treasury bond fund.
  • You expect your growth rate to average to 6.5%.
  • You want to amass $1.1 million.

Using those numbers, your calculator will tell you to invest about $1,060 monthly to reach your goal. That value is within your annual 401(k) contribution limits. And, the money doesn’t have to come entirely out of your pocket — your employer match can foot some of the bill.

Addressing an Unrealistic Monthly Investment

It’s possible the monthly investment needed to reach your savings goal is higher than your budget will allow. In that case, start investing whatever amount you can afford right away. The money you invest today has more growth potential than money invested tomorrow.

Then, rethink your plan. This is another area where an experienced financial advisor or planner can help you identify the best course of action. You can either raise your income, lower your living expenses, or delay retirement:

  1. Raise your income. Get a promotion, start a side hustle, or pick up a part-time job. Use the extra money you make to save more to your retirement account.
  2. Lower your living expenses. Pay down debt, spend less on discretionary purchases, shop around for cheaper insurance, switch to a no-fee, cash-back credit card that you pay off monthly. You could also downsize your home or your car. Use the savings to raise your retirement contributions.
  3. Delay retirement. Delaying retirement gives you more time to make retirement contributions. It also earns you a higher Social Security benefit. The drawback is that you end up with fewer years to enjoy your retirement.

5. Earmark Funds for Healthcare

Even if you are very healthy today, you’re likely to see higher healthcare costs in retirement. You should address those costs in your projected retirement budget, but you can also earmark healthcare funds in your investment accounts.

A good strategy is to invest in a Health Savings Account or HSA if you are eligible. You can make pretax contributions to an HSA if you have a high-deductible health plan (HDHP). Your benefits administrator or insurance representative can verify if your plan qualifies as an HDHP.

HSAs work like 401(k)s. In both accounts, you contribute pretax money, invest it, and your investment earnings are tax-deferred. Your HSA, however, allows for tax-free withdrawals to cover qualified medical costs at any age. You can use those withdrawals to fund your copayments, coinsurance, and certain supplies like eyeglasses and contact lenses. Paying for these with pretax money essentially gives you an automatic discount on your out-of-pocket healthcare expenses.

Another nice feature of the HSA is the ability to take non-medical withdrawals without penalty after you turn 65. These non-medical withdrawals are taxable, just like your qualified requirement withdrawals from your 401(k). Raise your HSA balance high enough and it saves you money on healthcare, while functioning as a backup retirement fund.

The HSA annual contribution limits in 2023 are $3,850 if you have individual health coverage and $7,750 if you have family coverage.

6. Monitor and Adjust

You know your target income, your target savings balance, and the monthly amount you need to invest across your 401(k), IRA, and HSA. Now, your job is to make those contributions and monitor your results over time.

Admittedly, investment performance is tough to monitor against a goal. This is because you project the plan with a long-term average annual growth rate — but your actual performance from year to year won’t match that long-term average.

To understand how you’re tracking, compare your investment results to the overall market performance every six months or so. If the stock market is down 5% and your account is down 5%, you’re on track. But if the market is up 12% and your account is up 2%, you need to rethink your investment strategy. Dig in and figure out where you’re falling short. It could be high fees, poor investment selections, or both. Make adjustments as needed.

Continue monitoring and adjusting, but with the goal of identifying investments you can hold for decades. Keeping your retirement portfolio stable is generally better for your long-term performance than frequent trading.

Once you’re happy with your portfolio, you can focus on finding ways to raise your monthly contributions. With every increase, you can go back to your retirement calculator and recast your long-term growth projection.

Create the Retirement You Want

After a few years of ongoing investments, your account balance will start to gain momentum. That’s when retirement planning gets really exciting. You know your efforts are paying off and you are creating the retirement you want.