There isn’t a ‘one-size fits all’ amount you should save for retirement. There never has been and never will be. People are different. They have differing definitions of retirement, spending patterns, priorities, number of beneficiaries, etc. As a result, some people can retire with a significantly smaller amount in assets than others.
When calculating how much you should have set aside for retirement, there are a lot of questions to ask yourself. First things first, what does retirement actually look like? Does it mean not working at all, or just not as hard or as much? Then, what are your usual monthly expenditures? Have you ever prioritized them? What are your sources of income? What is the difference between your estimated monthly outflow and inflow once you retire? If it is a shortfall, how do plan to make it up? What levers can you pull?
With these questions in your mind, it is time to construct a ‘personal financial statement (PFS).’ Put all of your assets on one side of the page, and be realistic about it. On the other, be honest about your liabilities. Subject the latter from the former, and that is your net worth. Basically, that is how much money you have for retirement.
Let’s assume your monthly cash budget will be $15,000 when you retire. Between Social Security and some 1099 income, you think you will bring in about $7,500 each month, on average. Obviously, you will need to make up that $7,500 gap somehow. You have done a PFS, and your net worth is around $1.5 million.
Clearly, you have the ability to pay the bills, but how and for how long?
Everyone’s PFS will be different; however, a general rule of thumb is you can budget up to about 4% of your net worth, annually, as a source of funds without eroding your purchasing power too much over time. Of course, this is an imperfect science, as a lot will depend on the composition of your PFS. Is it liquid? Is it growing? By how much? How much is in investments? How much is the equity in your primary residence? After all, you have to live somewhere.
However, going back to our example, your monthly shortfall of $7,500 works out to be $90,000 annually. That is 6% of your net worth. Are you making that amount on your money? Are you anywhere close? How easy will it be to get the necessary $90,000? If the answers to these questions present logistical and financial problems, you either: 1) need to reassess how much money you will spend in retirement, or; 2) need to have more money set aside.
In the end, the question isn’t how much you need to save for retirement as much as how much you plan to spend when you are retired. You work backwards from there.