The most important retirement chart I have ever seen

How much do you need to retire? And, equally important, how do you achieve that goal? These questions baffle many American savers, and it’s no wonder. Financial experts throw numbers for retirement savings ranging from $ 1 million to $ 5 million, along with confusing rules about how much you should save, what your retirement expenses will look like, and how much you can withdraw from your portfolio each year.

Let’s try to clear up that confusion right now with real life numbers. The following table shows the estimated retirement income, savings goals, and monthly contributions required for different salary levels and terms. As is the case with any retirement projection, these numbers carry various assumptions, which are explained below the table. Review those explanations carefully; They can help you build retirement projections tailored to your situation.

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Data source: author’s calculations

Estimated required income from savings

The amount of income you will need to generate from your retirement savings depends on your retirement living expenses. An old guide advises you to plan to need 70% to 80% of your earnings to cover your retirement expenses.

But that’s overly optimistic today, particularly if you retire with a mortgage, credit card debt, or student loan. Some expenses will disappear, like retirement contributions, but others will increase. The big wild card expense in retirement is healthcare. A study by the Center for Retirement Research at Boston College estimates that the average retiree will spend $ 4,300 annually on out-of-pocket medical expenses, not including long-term care.

Therefore, it is wise to assume that you will need 100% of your earned income for retirement. Social Security generally replaces 30% to 40% of that, depending on when you claim it. The table above assumes 30%, which means that your savings will finance the remaining 70%.

Savings target and the 4.5% rule

Once you know how much income you need from your savings, you can do a quick calculation to translate that into a target savings balance. Just divide your income number by 4.5%, or 0.045. If you need your savings to generate $ 70,000 in annual retirement income, for example, you would aim to accumulate at least $ 1,555,556 in your retirement account.

This calculation is based on the idea that you can safely withdraw 4.5% of your retirement savings in your first year of retirement. Thereafter, you can adjust your distribution to keep pace with inflation. At that withdrawal rate, a 50% portfolio in stocks and 50% in bonds should remain solvent for 30 years, even through bear markets that rival the most volatile times in history.

Average annual profitability, inflation and taxes

Now for the fun part, which is understanding how to reach your target savings balance. You can use any online composite earnings calculator to play these numbers on your own. You will need to assume an average annual growth rate. The table above assumes a growth rate of 7%, which is in line with the long-term annual average of the stock market. You could use a lower rate to be conservative, but not higher. Even professional mutual fund managers don’t consistently outperform the market.

Inflation is another consideration when you project long-term earnings growth. Inflation in recent years has been around 2% annually. To keep things simple, the old retirement data does not assume inflation, but neither does it increase wages. In real life, your income should increase every year, and at least keep up with inflation. Know that if you want to project these numbers on your own and account for future salary increases, you should also take inflation into account.

Year-to-year taxes can slow your production of wealth, which is an argument for investing in a 401 (k) or IRA with tax advantages. On those accounts, you don’t pay taxes on your earnings until you withdraw the funds in retirement. Again, for the sake of simplicity, the chart assumes that you are investing in an account with tax advantages and have no annual taxes (although the above higher contribution amounts exceed federal limits). In 2020, you can contribute up to $ 19,500 in your 401 (k) and $ 6,000 in your IRA. For savers age 50 and older, the contribution limits increase to $ 26,000 for the 401 (k) and $ 7,000 for the IRA.

Takeaways

The highlight in this retirement chart is the contribution rate and how it changes based on your savings schedule. If you are 20 years old until retirement and have no savings, your target contribution rate is 36% of your salary. That is probably unrealistic. The next best option is to contribute what your budget allows now, and increase that contribution with each increase in salary. Plan to put any windfall cash gains into your IRA or long-term savings account, too.

A second big conclusion is the size of the savings balance you will need. Social Security will keep you out of poverty, but it will not finance the lifestyle you are used to. To avoid a big cut in lifestyle, most people need seven figures in the bank at retirement. You can only achieve that goal by taking your retirement savings seriously. Either you make difficult decisions now to save and invest, or you spend your last years simply dragging yourself.

Finally, you must invest in the stock market to achieve your savings goals. These projections use a growth rate of 7%, which is seven times higher than you would earn in a high-yield savings account. Stocks carry a risk of loss, but staying out of the market ensures that you will have to shrink once you stop working.

Don’t wait to save

It is much easier to accumulate large amounts of wealth when you start saving early. Protect your future and take your retirement contributions seriously today.