In an era when most workers are responsible for funding their own retirement, it’s an ever-present question: How much money will I need to put away? Unfortunately, there’s no one-size-fits-all answer. Figuring out the right size for your nest egg is a personal exercise, one that depends on your spending habits and future needs.

It’s an especially tricky pursuit for millennials. Even the older members of this generation—those born in the early 1980s—have another three decades before they hit the typical retirement age. Life has a funny way of deviating from our plans, especially over that length of time. However, there is a way to make an educated guess, one that can help keep your investment habits on message as you move closer to retirement.

The 4 Percent Rule

Over the past couple of decades many financial planners have touted the “4 percent rule” as a benchmark for how much investors can withdraw each year from their retirement accounts. The rule says that by taking out 4 percent of your savings in the first year of retirement and then adjusting subsequent withdrawals to keep up with inflation, the risk that you’ll outlive your money is relatively low.

You can use this same formula to calculate how much you’ll need to save. Suppose you project expenses of $60,000 a year when you retire. Based on the 4 percent rule, you’d need $1.5 million in your accounts to make that happen ($1,500,000 x 0.04 = $60,000).

The rule assumes you have a roughly even mix of stocks and bonds. Holding too much of the latter simply won’t supply the growth needed for a typical retirement, making a 4 percent withdrawal rate untenable.

Keep in mind that even if Social Security undergoes cuts down the road, the program will likely defray at least some of your retirement costs. The Social Security Administration has a benefits estimate tool that provides an approximation of what you’ll receive based on your current income. And if you’re lucky enough to have a pension, you’ll also want to take that into account when figuring out how much you’ll need from investments.

Construct Your Budget

In order to use this approach, however, you have to have some idea of how much you’ll spend each year in retirement. For someone in their 20s or early 30s, that might seem like a herculean task.

One of the more common approaches is to base your retirement budget on your pre-retirement expenses. It’s often said that retirees will need around 80 percent of the income they relied on just prior to retirement. Needless to say, this method is less instructive for folks who are still decades away from age 65.

So here’s another way millennials can think about it: You’ll likely need a little more than you’re making now, as you’re at the front end of your career. Expenditures tend to increase as we progress in our careers and then peak just prior to retirement; After that they generally recede.

According to the U.S. Bureau of Labor Statistics, the average American in the 55 to 64 age bracket had $56,267 in total expenses in 2014, the last year for which data is available. Members of the 65 to 74 age group, meanwhile, saw annual expenses of just $48,885. Those in their late 70s and early 80s spent $36,673, on average. So if you’re 25 years old and spending $40,000 a year, allotting $70,000 a year for expenses in retirement—in today’s dollars—is probably putting you in the right ballpark.

Bear in mind that your individual circumstances may warrant a slightly higher or lower saving level. For example, if you’ve paid off your house by the time you retire, you may not need quite as much as your neighbors who are still chipping away at their mortgage (housing is the number one expense for retirees, according to BLS figures). Your lifestyle also plays a big role here. If you hope to trot around the globe when you get older, you might need to squirrel away more cash than folks with more-modest plans.

Don’t Forget Inflation

Chances are that the dollar bill in your back pocket will only retain a fraction of its worth 30 or 40 years from now. So when you’re estimating the 401(k) balance you’ll need, forgetting to think about inflation would be a huge mistake.

Suppose you use the 4 percent rule and, after factoring in Social Security, determine that you need assets of $1 million in today’s dollars. Now assume a long-term interest rate of 3 percent. By 2055 you’d need $3 million to have that same level of purchasing power.

That might seem disheartening, but keep in mind that wages tend to move upward along with prices—indeed, wage increases are one of the main causes of inflation—so you’ll likely be earning a lot more down the road.  If you save a fixed percentage of your income, your investments should be able to keep up.


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