A Simple 7 Step Retirement Plan

by Gary Foreman

A Simple Retirement Plan photo

How much money will you need to retire? Use this simple retirement plan broken down into seven easy steps to find out.

Dear Dollar Stretcher,
How much money will I need to save to retire? With inflation and earnings and taxes, it’s almost impossible to figure it out!
Concerned

Have you ever said that? Well, you’re not alone. In fact, many people haven’t begun to think about retirement planning because it just seems ‘too complicated’.

Suppose you could put a simple plan together that required nothing more than a couple of phone calls, a calculator and a little basic math? Would you do it? Here’s your opportunity. We’ll break it down into seven simple steps.

1. How much income will I need?

Good question. Experts used to suggest that you’d need about 50% of your pre-retirement income to maintain the same standard of living. Recently, they’ve begun to increase that percentage, with some going as high as 85% of your current income. I’m cautious, so I’m going to use a figure of 80%. You choose your own figure.

Travel and expensive hobbies will require a higher number. Remember, throughout this exercise, it’s better to have too much money available when you retire rather than too little! So you might want to estimate on the high side.

Suppose my current annual expenses are $75,000. Multiply that by 80% and I’ll need about $60,000 to live the way I do today. ($75,000 X .8 = $60,000)

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2. How much of that will Social Security provide?

Another good question. We’ve all read that the trustees of Social Security say that the fund will be empty by 2033. Should you include Social Security income in your plan? That’s up to you. For our exercise here, I’m going to include it so you know how.

You can contact The Social Security Administration to find out how much your expected benefits will be (1-800-772-1213). They’ll send you a form to request the information. For today, I’m going to use a benefit of $2,533 per month. That’s just a shade under $30,400.

3. What about my company pension?

That’s where the other phone calls come in. You’ll need to contact your employers to find out what the annual income of your pension will be. Some plans are guaranteed, others will provide an estimate. You’ll use the number they give you. For our illustration I’m going to use a $20,000 figure.

4. How much will need to come from retirement savings accounts?

Next we’re going to calculate how much income you’ll need to provide from your own savings and IRA’s. We’ll do that by subtracting the Social Security and pension income from our income requirements in step one.

So in our sample case, I’ll need $9,600 in annual income. ($60,000 – $30,400 – $20,000 = $9,600)

5. How much money will I need to save to have the income from Step 4?

That depends on how much your investments earn. Lately it’s been easy to get a good return after inflation and taxes. But over the long term, if you earn 4% or 5% you’re doing pretty well.

Remember, these are after-tax, after-inflation earnings. Let’s use the 5% estimate for our worksheet. Divide the income you want by the rate of earnings you expect. I’ll need a nest egg of $192,000 to provide $9,600 in yearly income. ($9600 / .05 = $192,000)

6. What about the money I’ve already saved in IRA’s, etc.?

We’ll not only want to include that money, we’ll need to estimate how much it will be worth when you retire.

First, take a look at your IRA’s and other retirement savings and see what they’re worth today. Suppose you’ve saved $40,000 so far.

What’s it going to be worth when you retire? We going to use a little trick called the Rule of 72. It says that if you divide 72 by the rate of return, the answer will tell you how long it would take your money to double. So if we expect to earn 5%, then our money would double in 14.4 years. (72 / 5 = 14.4) For simplicity’s sake let’s say it will double every 15 years.

So how long will it have to grow? Depends on your age and when you plan on retiring.

I’m going to illustrate a 45-year-old who wants to retire at 65. Our friend would expect his current savings to be worth about $100,000 at retirement. Remember that our money will double every 15 years. So it’ll be worth $80,000 at age 60 ($40,000 X 2). The extra five years between age 60 and 65 will add about another 25% of the principle ($80,000 + $20,000 = $100,000).

7. How much do I need to save starting now?

We’ll need to save about $92,000 ($192,000 – $100,000 = $92,000). You could just divide the amount you need by the number of years before retirement to figure your annual savings goal.

And if you’re over 50, that’s probably a good idea. But if you’re younger you should consider the earnings on your savings.

Say you’re about 40 years old. The money you save by age 50 will double by the time you reach retirement. So if you could save one-third of the $92,000 between now and age 50 you’d do fine. The first $30,000 would grow to $60,000. You’d save another $30,000 between ages 50 and 65 to reach your goal of $90,000.

What about our 30-year-old? He’s about 35 years from retirement. If you’re that far from retirement, here’s an easy rule of thumb. Divide 100 by your expected rate of return. If you said you’d earn 5% after inflation and taxes, you’d end up with 20%. That’s the percentage of your total nest egg you need to save by age 40. So you’d plan to save $20,000 ($100,000 X .2 = $20,000) in the next 10 years. Or about $2,000 each year.

By now you should have some idea of how much you’ll need to save for retirement. You probably hear a rumbling in the background. It’s the sound of accountants and financial planners pointing to flaws in this simple model. And, truth be told, they’re right. It is overly simple. It’s designed to get you started. There are plenty of more exact tools available to help you be more precise. And it’s a good idea to use them. But some of you are reluctant to take the first step. We just eliminated that excuse!

You’ll want to revisit your program about once a year to see how you’re doing. As you get closer to retirement you can ‘fine tune’ the program. But the important thing isn’t to pinpoint the savings needed each week beginning today. You can always adjust your savings up or down. What’s important is to get a feel for your direction and to get going.

There you have it. A very simple approach to getting your retirement program started. So what are you waiting for?

Reviewed December 2020

About the Author

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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