How to calculate retirement income?

Preparing for retirement involves more than just stashing part of your earnings for retirement. You will need to figure out how much retirement income you will need during your golden years and create a plan to ensure you have built enough retirement savings to maintain your lifestyle.

To calculate your retirement income, you will need to estimate your retirement expenses and retirement income. You should consider all sources of retirement income including Social Security, 401(k), IRA, savings accounts, and investment accounts. Then, calculate the gap between your retirement expenses and your retirement income to know how much you will need to fill the income gap.

How to calculate your retirement income

When calculating your retirement income, you will need to estimate your expected retirement expenses and compare them against your guaranteed sources of retirement income.

Follow these steps to calculate the amount you will need to retire:

Calculate your retirement expenses

The first step is to estimate the expected expenses in retirement, depending on your desired lifestyle. Create a list of your expenses in each spending category, and the changes you expect to make when you retire.

For example, if you plan to travel more, you should estimate the amount you will need in air tickets, accommodation, gas, etc. depending on the countries you expect to visit. If you plan to move to another state, you should consider if the cost of living will be higher or lower, and the expected costs like rent, taxes, groceries, etc.

Calculate your retirement income

Consider all the sources of retirement income that you expect to tap into in retirement. Do you have 401(k)s and IRAs and how much retirement income will they provide? Are you eligible for Social Security, and how much benefits do you qualify to receive? List all your retirement, savings, and investment accounts that you plan to use to fund your retirement so that you know how much income will be at your disposal.

Determine the gap

Once you have determined your expected retirement expenses and the retirement income at your disposal, you should determine the income gap. For example, if you determine that you will need $80,000 to meet your retirement expenses, and you will receive $20,000 from Social Security, it means there is an income gap of $60,000 that you will need to plug from your other sources of income, including 401(k), IRA, savings accounts, and investment accounts.

How much money do you need to retire?

The amount you will need to retire depends on various factors, including your expected expenses in retirement, your desired retirement lifestyle, and how long you will live. While there no is one-size-fits-all value, there are several concepts you can use to determine the amount you will need.

The 4% rule of thumb

One of the concepts you can use is the 4% rule, which recommends withdrawing 4% of your retirement savings in the first year and adjusting subsequent withdrawals for inflation for the money to last at least 30 years.

For example, if you have a nest egg of $1 million, you could withdraw 4% in the first year of retirement. This is equivalent to $40,000 in the first year. In the second year of retirement, you should adjust this amount for inflation. If the rate of inflation is 3%, you could withdraw $41,200 ($40,000 x 1.03). In the third year of retirement, you should use the prior year’s withdrawal, and adjust the amount for inflation to determine the withdrawal amount.

70% replacement ratio

You can also estimate the amount of retirement income you will need based on your current income. The 70% replacement ratio aims to replace 70% to 80% of your pre-retirement income to maintain your current lifestyle. You can replace your current income using a combination of incomes, including Social Security, savings, investments, pension, retirement plan withdrawals, etc.

However, you should determine how much your expenses will change. If you will have paid off your mortgage when you retire, you can replace 60% to 70% of your income. However, if you expect costs like healthcare and travel to increase in retirement, you may need to replace 80% to 100% of your pre-retirement income.

What percentage of my income should I put into my retirement savings?

The ideal amount you should set aside each month may vary depending on your financial situation, retirement goals, and lifestyle. Here are factors that can determine the ideal percentage to save:

Time until retirement

If you start saving for retirement earlier, you have a long time horizon until retirement, and your money has more time to grow through compounding. You may be able to stash a smaller percentage of your salary towards retirement over a long time, and still accumulate your target nest egg. However, if you are closer to retirement age, you will need to contribute a bigger percentage of your income to catch up and meet your target retirement savings goal.

Retirement lifestyle

Your spending in retirement will likely not be the same as your current spending, depending on your desired lifestyle. While some costs related to work like commuting costs, business attire, and childcare will go away, you will incur additional costs in retirement that you may not have today.

If you anticipate traveling more, exploring your hobbies, outsourcing home-related tasks, and paying higher medical costs, you may need to save a bigger percentage of your income to meet your goals. However, if you anticipate a more laid-back and modest retirement lifestyle, contributing a small percentage of your income may be enough to meet your needs in retirement.

Employer match

If you contribute to an employer-sponsored plan such as 401(k) and 403(b), you should contribute enough to maximize employer-matching contributions. If you start saving early and taking advantage of the employer's match, you can contribute a lower percentage of your income to meet your target. For example, if you contribute 4% and your employer matches 4% in your retirement plan, you will make a 100% return on your contribution.

Pre-retirement income

You can use your pre-retirement income as the basis for estimating your spending in retirement. For example, if your current annual income is $100,000, you will need to replace a percentage of your annual salary, usually 70% to 80% of your current income. Replacing 70% of your annual income may be too high if you have not saved enough, and you will need to contribute a higher percentage of your salary to catch up. If you can afford it, you can save at least 15% of your annual salary, and maximize the employer’s match.