This article first appeared at US News and World Report Money.
At some point during each of our professional lives, we wake up to the fact that we really need to be saving for retirement (hopefully, we figure it out when we’re young).
We’re all going to retire, and that means we’re all going to need some money put aside for us for retirement.
The problem is that when we think broadly about saving for retirement, it seems impossible. A million dollars? More? How are we going to possibly come up with that kind of money?
Here’s the catch: none of those retirement articles out there, the ones that talk about having to save millions, are writing about your situation. Instead, they’re writing about someone else, often someone earning a lot more than you.
What you need is a plan that works for you, and that starts with having a good target number for retirement savings.
Steps to Calculate Your Retirement Number
I’m going to walk through exactly how I would calculate anyone’s retirement number. All you need is your most recent Social Security statement along with how much you made in the past year as well as the number of years between now and when you plan to retire. You’ll also need a web browser with Google ready to go and a piece of scratch paper.
Step 1: Project How Much You Will Live on Retirement
The first thing you need to figure out is what your current salary will look like when you retire, because this whole plan is based on the idea that you’ll live on your current income when you retire. If you plan on living on 80% of your salary or some other percentage, head to Google right now and type in “80% of $40,000” or whatever your salary is so that you have the right amount. I usually suggest people use 80% of their salary for their retirement number because they will no longer have work-related expenses.
Step 2: Calculate Your Inflation Factor
I’m going to assume that long-term inflation is at 3%, which is based on a high-end estimate from the Federal Reserve as seen here – http://www.clevelandfed.org/research/trends/2013/0413/01infpri.cfm
So, you should go to Google and type in “1.03^” followed immediately by the number of years between now and when you expect to retire. So, if you expect to retire in 18 years, you’d type in 1.03^18.
Now, take that number and multiply it by your salary (or whatever you decided to use above). If you’re using Google, you should already have a calculator there with the first number already entered for you. If you were using $32,000 per year (80% of $40,000) and you’re retiring in 18 years, for example, it will give you $54,477, which is what your salary will look like 18 years in the future with normal inflation.
Step 3: Subtract Social Security or Pension Benefits (if any)
From that, you need to subtract what you’ll receive annually from Social Security, so pull out your Social Security statement and look for your annual benefit. Subtract that from your salary above. In this example, a person might have an annual benefit of $15,000 from Social Security, so their new number would be $39,477.
Step 4: How Long Will You Be Retired?
Now, that annual amount is going to have to last you for a while. I usually assume that people will spend 25 years in retirement (as an average), but that their investments will continue to earn a return while they’re retired. So, I tell people to multiply that salary number by 20, which is your final step.
So, a person who is making $40,000 per year and is 18 years from retirement needs to save $789,577 for retirement.
This is a quick calculation, of course, and it’s also not as scary as you might think that it is, particularly if you’re far from retirement. This person, who receives a 1:1 employer match on their 401(k) up to 6% and hits all of that while also fully funding a Roth IRA each year, would be pretty close to being on pace for that number. Someone starting earlier might not even have to push that hard. Someone starting later might have to save even more or consider waiting a year or two longer to retire.
The lesson of this story is simple. Start saving now. You’re going to need quite a bit of money to retire, and every year you put it off the harder you’re making your savings journey.
If you need a little help deciding when and how to start saving for retirement, check out these resources: