Saving for Retirement

Populations around the world are aging, so in the future governments will be less able to support the retired. This means we should all be arranging our finances to provide for our retirement, but how much money will we need?

The answer to that question depends on how you answer two others: how many years of retirement do you expect to have, and what standard of living do you want to maintain?

When retirement ends is out of our hands, but we can decide when we want to finish work. In most western societies the expected or default retirement age is 65. Given that life expectancy is now around 80, that means we need enough money to live for at least 15 years, and possibly longer. Many people would like to finish work earlier, or at least reduce the number of hours they work, but that hits retirement planning in two ways: more money is needed to last a longer retirement but there are fewer years in which to save.

The question of what standard of living you want in retirement is harder to answer. Twenty years ago the standard advice was to figure on 60% of your pre-retirement income, but today many experts suggest 80 to 100%.

Why the increase? Well for many people the first few years of retirement resembles an extended vacation, so think about how you spent money the last time you were away. You probably took a few trips to nearby places of interest, ate out a few times, browsed antique shops or squeezed in the odd round of golf. That might be your ideal retirement, but it doesn’t come cheap.

So how much money do you need to save to enjoy your golden years? The simple answer is, as much as you can, especially if, like most people you put off signing up for that private pension plan until you were nearly thirty. In fact if you’re one of those late starters you should aim to save around 20% of your gross income.

Why so much? Well let’s go through a simple example, and we’ll keep it general rather than make this specific to any one country.

Imagine your pre-retirement income is $60,000 a year. You plan on downsizing your house so there will be no mortgage, and you want to take a few trips, maybe treat the grandkids to a week at Disney, and sign up for that watercolor class you’ve always promised yourself.

What income will you need? Well probably around the same as when you were at work: $60,000. Now, do you need to save enough money to generate that much income?

That depends on what kind of pension you expect to get from the government – the Department of Work and Pensions, if you’re in the UK or Social Security in the US, for example – and often that depends on how many years you worked and at what age you want to start drawing down that pension. (Taking it before you’re 65 usually shrinks the monthly check quite considerably.) Everyone’s situation is different but let’s say for this example that you’ll be receiving $15,000 per year. That means you’ll need to generate $35,000 per year from your own savings.

Retirement experts say that each $100,000 saved will provide an income of around $6,000 per year, but that assumes that you’ll be dipping in to the principal rather than living off the interest alone. In other words, at that rate you’ll run out of money after twenty years or so. If you’re hoping for a longer retirement you may want to figure on $5,000 per $100,000 saved.

Simple math tells us then that you’ll need a retirement fund of $700,000. That’s a lot of money, so start saving!

Fortunately, there a couple of things that help. First, most governments let you save for retirement with pre-tax money. That means you only need to put aside 70 to 80 cents (depending or your tax rate) to save a dollar. And second, if you’re in your twenties or thirties, time is on your side. The money you invest now will have thirty years or more in which to grow, but don’t use that as a reason to put off joining a pension plan. Every day matters!

If you want to work out details specific to your situation you’ll find investment and retirement planning calculators on the web sites of all the big investment companies. Vanguard and T.Rowe Price are two you might visit.