A 2020 survey by Schwab Retirement Plan Services [1] found that the average 401(k) participant believes they will need $1.9 million to retire, up 12% from the previous year's survey. Of course, many people in the U.S. are not investing enough to reach that savings target and the income it generates.

To determine whether retirement income will be sufficient, start by estimating retirement expenses.

Retirement expenses

Several formulas estimate retirement expenses, all rough guesses at best. One familiar rule says you will need about 80% of what you spend to retire. This percentage assumes some major expenses decline in retirement, including commuting costs and retirement plan contributions. 

Other expenses may increase, of course, such as vacation travel and, inevitably, health care.

Many retirees report that early-retirement expenses not only match but sometimes exceed their working-life spending. One reason is that retirees may simply have more time to go out and spend money.

Retiree spending commonly goes through three distinct phases [2]:

1. Higher spending at the beginning
2. Modest spending for a long period afterward
3. Higher spending near the end of life because of medical or long-term care costs

Many retirees find they spend the most in both the earliest and latest retirement years.

Standard of living

Future expenses are difficult to predict, but the closer you are to retirement, the better you likely understand how much money you need to maintain your current standard of living or support a different one.

Using that as a starting point, subtract expenses you expect to disappear after retirement and add new ones. This gives you at least a rough working estimate.

If you anticipate large bills—much more travel or a new kitchen—include them in planning. Do the same for major savings, such as downsizing to a less expensive home.

How much do I need to retire?

Many financial advisers reduce the answer to a rule of thumb, at least as a starting point: a 4% sustainable withdrawal rate.

Essentially, this is the amount you could theoretically withdraw through good times and bad while still expecting the portfolio to last at least 30 years [3]. Not all experts today agree that a 4% withdrawal rate is optimal, but most argue you should try not to exceed it.

Following the 4% rule, these are the annual withdrawals available from three savings balances:

• $500,000—$20,000 a year
• $1 million—$40,000 a year
• $2 million—$80,000 a year

To calculate the income needed in retirement, take your estimated monthly expenses—make sure they are realistic—and divide by 4%. For example, if you estimate needing $50,000 annually to live comfortably, you will need $1.25 million ($50,000 ÷ 0.04) to retire.

Retirement income

Now that you have an idea of retirement expenses, determine whether income will cover them. Add the income expected from three key sources:

1. Social Security retirement benefits
2. Defined benefit pension plans
3. Retirement savings

Social Security retirement

If you have worked and contributed to Social Security for at least 10 years and earned 40 credits, you can obtain a benefit projection using the Social Security Retirement Estimator [4]. The closer you are to retirement, the more accurate the estimate.

Remember that the earlier you claim benefits, the less you receive monthly. You can begin as early as 62 or as late as 70, after which there is no further incentive to wait because you receive the full amount whether you are 70 or older [5].

In June 2020, the average Social Security retirement benefit was $1,514 monthly [6]. The maximum depends on your age when you begin claiming.

For 2021, the maximum monthly benefit is:

• $3,895 if you claim at 70
• $3,113 if you claim at full retirement age, 66
• $2,324 if you claim at 62

For tax year 2022, maximum monthly benefits are:

• $4,194 if you claim at 70
• $3,240 at 66
• $2,364 at 62 [7]

Social Security and Supplemental Security Income (SSI) benefits for approximately 70 million Americans will increase 5.9% in 2022 [8].

Defined benefit plans

• If you receive a pension from a current or former employer, the plan benefits administrator can estimate how much you will receive when the time comes.
• If you have a spouse, consider likely income under different scenarios, such as receiving benefits through a joint-and-survivor annuity, which continues paying a specified percentage of benefits to your spouse if you die first.

Retirement savings

Retirement savings include everything saved in your 401(k), IRA, health savings account (HSA), and other accounts earmarked for retirement, such as cash value life insurance.

If you have a traditional IRA or 401(k), you must begin required minimum distributions (RMDs) at 72. Note that Roth IRAs have no RMDs during your lifetime, although Roth 401(k)s do. Those RMDs determine monthly income from these accounts once you turn 72 [9]. Still, you can begin withdrawing from an IRA or 401(k) at 59½ without penalty [10].

Your personal bottom line

After adding everything up, if total retirement income exceeds expected expenses, you probably have enough for retirement—though more certainly would not hurt. If you appear likely to fall short, adjustments may be needed to increase income, reduce expenses, or both. For example, you could:

• Work a few more years, if possible.
• Increase the portion of pay set aside for retirement.
• Adopt a more aggressive investment strategy.
• Reduce unnecessary expenses, always a good choice.
• Move to a smaller, more affordable home.

The sooner you calculate, the more time you have to make the numbers work in your favor.

Saving versus investing

It is worth noting that one year earlier, nearly two-thirds of participants in the 2019 Schwab study [1] considered themselves savers rather than investors [11]. That approach can result in lower returns and retirement account balances.

People generally save for purchases and emergencies. The money is there when needed, with a low risk of losing value and limited potential gains.

Investing, by contrast, serves long-term goals. It offers the potential for better long-term returns but involves more risk. The key is balancing risk and reward based on your risk tolerance and time horizon.

Savings rates: what is enough?

Although a dollar target is useful for long-term saving, it also helps to focus on how much to save each year.

Ten percent is the historically recommended savings rate. Starting at age 20, you can retire comfortably with a 10% to 15% savings rate [12]. Here are possible scenarios for a future retiree.

A 5% retirement savings rate

Suppose Bertha, age 30, earns $40,000 annually and expects 3.8% raises until retirement at 67. With a diversified portfolio of stock and bond mutual funds, she also expects a 6% annual return on retirement contributions.

At a savings rate of 5% throughout her working life, Bertha will have saved $423,754 by 67. If she needs 85% of preretirement income to live and also receives Social Security, her 5% retirement savings fall significantly short of the goal.

To replace 85% of preretirement income, Bertha needs $1.3 million at 67. A 5% savings rate does not bring her savings to even 50% of the funds needed. Clearly, saving 5% for retirement is insufficient.

Savings rates of 10% and 15%

Keeping the same salary and expectations, a 10% savings rate gives Bertha $847,528 by 67. Projected needs remain $1.3 million. Even at 10%, she falls short of her desired savings amount.

If Bertha increases saving to 15%, she reaches $1.3 million. Adding expected Social Security would fund her retirement.

Does this mean people who save less than 15% of income are doomed to a substandard retirement? 

Not necessarily.

Conservative assumptions

As with any projection, we have made assumptions. Investment returns could exceed 6% annually. Bertha might live in a low-cost area where housing, taxes, and living expenses are below U.S. averages. She might need less than 85% of preretirement income or choose to work until 70. Her salary might grow faster than 3.8% annually.

All these optimistic possibilities would produce a larger retirement fund and lower retirement living expenses. In the best case, Bertha could save less than 15% and still have sufficient retirement savings.

What if the initial assumptions are too optimistic? 

A more pessimistic scenario includes lower Social Security payments than today. Or Bertha may not stay on the same positive financial path. In the 2019 Schwab study, for example, one-quarter of participants had taken a 401(k) loan, and most had taken more than one [11].

Alternatively, Bertha could live in Chicago, Los Angeles, New York, or another high-cost area where expenses greatly exceed those elsewhere. Under these less favorable assumptions, even a 15% savings rate might not support a comfortable retirement.

Measuring your needs

If you have reached midcareer without saving as much as these numbers suggest, plan additional savings or income streams from now on to close the gap.

Alternatively, consider retiring somewhere with a lower cost of living so money lasts longer. Working longer can also increase Social Security benefits and earnings. Remember that Social Security is higher if you wait until full retirement age to claim, and higher still if you delay until 70.

If you want a single retirement savings target, guidelines can help. Some advisers recommend 12 times annual salary. Under this rule, a 66-year-old earning $100,000 would need $1.2 million at retirement. But as earlier examples show—and because the future is unknowable—there is no perfect retirement savings percentage or target.

Better to be prepared…

Retirement planning is not something to begin shortly before stopping work; it is a lifelong process. Throughout your working years, planning passes through stages in which you evaluate progress and goals and make decisions to ensure you reach them.

A successful retirement depends not only on saving and investing wisely, but also on planning. Knowing how much retirement income you will need can be difficult, making planning difficult too. One thing is certain: being overprepared is much better than improvising.

References

1. Charles Schwab. ' Schwab 401(k) Survey Finds Savings Goals and Stress Levels on the Rise '.
2. Fidelity. ' How Much Will You Spend in Retirement? '
3. Fidelity. ' How Can I Make My Retirement Savings Last? '
4. Social Security Administration. ' How You Earn Credits ', page 2.
5. Social Security Administration. ' Learn About Retirement Benefits', select 'Deciding When to Start Retirement Benefits '.
6. Social Security Administration. ' Monthly Statistical Snapshot, June 2020 ', select 'Table 2'.
7. Social Security Administration. ' Workers with Maximum Taxable Earnings '.
8. Social Security Administration. ' Social Security Announces 5.9 Percent Benefit Increase for 2022 '.
9. Internal Revenue Service. ' Retirement Plan and IRA Required Minimum Distributions FAQs '.
10. Internal Revenue Service. ' Retirement Topics—Exceptions to Tax on Early Distributions '.
11. Charles Schwab. ' 401(k) Participant Investing Behavior May Leave Them Short '.
12. Charles Schwab. ' How Much Should I Be Saving? '