3 Ways to Calculate How Much to Save for Retirement - The Motley Fool

Do you know how much money you need to save for retirement? If you do, you're part of a small minority of Americans. Employee Benefit Research Institute's recent survey found just 42% of all Americans had attempted to calculate the amount of money they'll need to support themselves in their senior years. 

One reason why so few Americans have figured out their magic number: It's complicated to estimate the amount of income you'll need to support yourself decades from now for an indeterminate length of time. But while it can be difficult to set a clear retirement savings goal, there are some tried-and-true techniques you can use to figure out how much to save.

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1. Set your retirement budget and work backwards

The most accurate -- but most complicated -- method of figuring out your retirement savings goal is to determine the amount of cash you'll need as a senior and then figure out how much savings you'll need to produce it.

This technique works best if you'll be retiring soon, as it can be almost impossible to anticipate expenses decades from now. But if you're pretty close to retirement, you can look at your current expenses, figure out which will remain when you retire, and add in any new spending you anticipate. 

Say you're spending $50,000 per year -- but that includes $10,000 on a mortgage that'll be paid off before you retire, as well as $1,500 in commuting costs and clothing for the office. Your spending would go down to $38,500, but you might want to add in an extra $2,000 for a big vacation you plan to take each year. In this case, you'd need $40,500. And of course, you can't forget to add in money for additional healthcare costs you might need as you age -- the costs of which could be over $4,000 per year or more.  

Once you have an estimate of how much you'll need, figure out the amount you'll get from Social Security and other sources of funds, such as a pension. You can estimate your Social Security benefits using a calculator on the SSA website, but keep in mind that the calculator won't be exact.

To determine how much money you'll require your investments to produce, subtract the income you'll get from these other sources from the amount of income you'll need. If you need $45,000 and get around $17,500 from Social Security, you'd need your retirement accounts to produce $27,500 in income. 

Then use the 4% rule to see how much you need in savings. The 4% rule estimates a safe withdrawal rate of 4% of your savings in the first year of retirement (you'll then increase this amount by inflation each year). If you need your retirement account to produce $27,500, multiply that number by 25 to see that you'd need $687,500 saved.

2. Work backwards based on a percentage of pre-retirement income

If you don't want to figure out your exact retirement budget or can't do so because retirement is too far away, you can estimate the amount of money you'll need as a retiree based on a percentage of what you're earning before you leave the workforce. 

Most financial experts recommend you have 70% to 80% of your final salary available to spend in retirement if you want to maintain your standard of living. If you anticipate being a big spender, err on the side of a larger percentage of pre-retirement funds. 

To use this approach, first estimate what your final salary will be by using your current salary and anticipating a 2% annual raise. So if you're earning $45,000, add 2% to $45,000 to figure out your likely salary a year from now -- then repeat this for each year until retirement.  The chart below shows what that would look like. 

Years to Retirement	Current Salary	Salary 1 Year Later After 2% Raise
10	$45,000	$45,900
9	$45,900	$46,818
8	$46,818	$47,754
7	$47,754	$48,709
6	$48,709	$49,684
5	$49,684	$50,677
4	$50,677	$51,691
3	$51,691	$52,725
2	$52,725	$53,779
1	$53,779	$54,855
0	$54,855	$55,952

Chart by author.

In this example, you'd have a final salary of $55,952. If you decide you need 80% of that amount for retirement, you'd need an income of $44,761. If your Social Security benefits are around $17,500, you'll need your investments to produce $27,261. Using the 4% rule, multiply this number by 25 to see you'd need about $681,525 invested to produce the desired retirement income. 

3. Assume you'll need 10 times your ending salary

Finally, financial experts recommend saving 10 times your final salary to have a secure retirement. You can figure out your final salary as described above -- use your current salary and assume a 2% annual raise for each year until retirement. Then multiply that number by 10. 

If your final salary is $55,952 based on the above calculations, this approach would indicate you need about $559,520 saved to support yourself as a senior. This is less than the amount you determined using the two methods above. But if you'd planned to spend 70% of your final salary instead of 80%, you'd have determined you need $541,660 -- so it's pretty close. 

Which method would work best for you?

As you can see, the three different approaches to calculating retirement income give you somewhat divergent answers to the amount of money you'd need, depending on the assumptions you make. Think about which approach makes sense for you, or try all three and choose the highest amount if you want to be sure you'll have cash to support you for the rest of your life. 

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