- 7-Minute Article
- Jan 29, 2018
Can I Afford the Retirement I Want?
Follow this step-by-step process to estimate potential income and expenses in retirement.
Updated: October 3, 2022
A common question among people planning for retirement is whether their savings and income sources will support the lifestyle they desire.1 While the “right” amount of savings depends on each person’s individual circumstances – including potential expenses, planned retirement age, and life expectancy – there is a way to begin assessing whether your plans for retirement are on track.
Here is a step-by-step approach to help you estimate potential retirement income and expenses and help you determine whether the current mix of savings and investments may be sufficient to support your retirement needs. Consulting with a financial professional during this process can help identify opportunities to strengthen your plan before retirement.
Step 1: How much will I have?
Start by calculating all guaranteed retirement income, such as pensions and annuities, as well as estimated Social Security benefit. Each person’s Social Security benefit will depend on a number of factors, including earnings history and the age at which they claim benefits, but the maximum Social Security benefit for a person retiring at full retirement age in 2022 (between age 65 and age 67) is $3,345 a month – or about $40,000 a year.2
To create a personalized estimate for Social Security benefits, use the Social Security Administration’s Retirement Estimator.
Next, estimate potential income from savings, including all assets in 401(k)s, IRAs, and other savings or investment accounts. A common guideline for income planning is to assume a 4% annual withdrawal rate from savings. The theory behind this rule is that using this assumed withdrawal rate can help calculate how much is needed to last for 30 years in retirement, based on historical returns of the U.S. stock market.3 But the 4% rule is just a starting point – it’s important to work with a financial professional to determine an appropriate withdrawal rate for individual circumstances.
Here’s how to perform the calculation to estimate a 4% withdrawal rate:
- Calculate the total amount of money in all financial accounts. For example, a person might have $750,000 in total savings.
- Divide that total by 25, which will provide a number equivalent to what a 4% annual withdrawal amount would be. In the case of our hypothetical $750,000 portfolio, the answer is $30,000 in annual income from investments and other savings.
Finally, list any other potential sources of income, such as pay from anticipated part-time work, income from rental properties, veterans benefits, or disability benefits.
Together, the figures from those categories — guaranteed income plus benefits from Social Security, withdrawals from savings and investments, and payments from other income sources — will help provide an approximation of total annual retirement income. A financial professional can be a valuable partner at this stage to help you develop more detailed estimates or answer questions about how much income to assume from different sources.
Step 2: How much money might I spend during retirement?
Many financial professionals advise replacing at least 80% of your pre-retirement income.4 That figure assumes that many of the typical expenses for a working family – including transportation, the cost of raising children, and the need to save for retirement – decline as we get older. Following that guideline, someone with a household income of $125,000 before retirement should try to generate roughly $100,000 annually from a range of income sources.
However, there are many variables that can affect how much a person may need:
- Some expenses might decline in retirement, including commuting and clothing costs once a person is no longer working. Housing expenses also might decline if retirees pay off their mortgages.
- Other costs are likely to increase in retirement, including discretionary expenses. A plan for retirement that includes more costly activities such as travel and dining out often should include appropriate estimates for those costs.
- Some essential expenses also tend to get more expensive in retirement, including medical costs. Individuals over age 65 can receive Medicare coverage for hospitalization and necessary medical expenses related to certain conditions, but many retirees choose to protect themselves with health care coverage options such as Medicare Part B (for routine medical care) and Medicare Part D (for prescription drug costs).
Consult a financial professional to help you explore these variables and develop personalized estimates for retirement income needs. These two tools can also help with the process:
- Our Future Income Planner provides a convenient way to pull together income and spending information and identify potential gaps. But remember: An estimate of annual expenses should then be multiplied by potential length of retirement.
- The Longevity Illustrator can help estimate length of retirement. It allows people to enter personal information and discover their odds of living to specific ages.
Step 3: Will retirement savings support spending?
The final calculation is to subtract estimated annual expenses from total projected annual income to reveal whether current savings and income sources can support a desired retirement lifestyle or show if there’s a gap that should be filled.
- For example, our hypothetical investor with a pre-retirement annual income of $125,000 and $750,000 saved might have a target annual retirement income of $100,000, based on projected expenses and desired lifestyle. If this person receives the maximum Social Security benefit but has no other sources of income, their total annual income would be $63,400 ($33,400 in Social Security income and $30,000 from investment withdrawals at a 4% annual rate) – so their gap would be $36,600 annually.
Step 4: How can pre-retirees address a shortfall?
There are several options to help address a retirement income shortfall. Consulting with a financial professional can help you build a strategy that works for your specific circumstances and might include the following:
- Assessing ways to boost retirement savings. For example, people with access to company-sponsored retirement plans might take advantage of wealth-building features such as receiving the maximum employer match for their annual contributions or signing up for automatic annual contribution increases. If a plan doesn’t offer those features, consider boosting regular payroll contributions at least once a year or devoting a larger portion of any raises or bonuses to retirement savings. Anyone over age 50 also can take advantage of annual “catch-up” contributions to retirement plans, including up to $1,000 per year for a traditional or Roth IRA or up to $6,500 per year for a 401(k) in 2022.5
- Delaying retirement. Working for a few more years provides more time to build savings and reduces the number of years those savings will have to support expenses. Retiring later also provides the opportunity to get a larger monthly Social Security benefit because each year a person delays claiming benefits past full retirement age (age 66 for people born between 1943 and 1959; age 67 for people born after) increases the monthly payment by about 8%.6 And because each person’s Social Security payment is based on the average salary of their 35 highest earning years, working a few years longer at a high salary also can boost a person’s benefit.
- Looking for additional sources of guaranteed income. Many financial professionals recommend covering essential expenses (such as food, housing, and medical costs) with guaranteed income. Adding an annuity can provide additional guaranteed income. Annuities turn a one-time payment or a series of payments into an income stream that can help supplement Social Security, pensions, and other guaranteed income sources.
- Adjusting targets for discretionary expenses. Living within a retirement budget might mean making small changes to nonessential expenses now. A financial professional can also help create a plan to balance short-term expenses with longer-term retirement savings goals.
Planning Ahead Provides More Time to Adjust
The earlier people begin the process of analyzing potential income and expenses, the more time they have to address any gaps in their plans. Taking control over retirement planning can help pre-retirees feel more confident as they approach their planned retirement date and feel more secure about the future.