Ever wondered how much you should save for retirement? The 4% rule can help.

Retirement saving can be a daunting topic, especially if you don’t know where to start. But luckily, there is a general guideline, called the 4% rule, which can help you determine how much you can comfortably spend each year from your retirement savings. This rule not only forecasts how much money you’ll need when you retire, but also what steps to take before retirement in order to meet your goal.

The 4% rule, which was developed in the ‘90s, states that you should be able to comfortably live off 4% of your money in investments in your first year of retirement, then slightly increase or decrease that amount to account for inflation each subsequent year. Nowadays, some financial planners suggest a percentage closer to 3.3%, however even following 4% as your guideline should allow you to use your retirement portfolio to cover expenses for 30 years.

The variation in the recommended percentage for the rule comes as a result of people living longer and therefore needing more money. Additionally, factors such as the specific environment in which you live, as well as your specific needs, can affect the amount that you’ll need to save up in order to have a comfortable retirement. Not to mention, if you live 25-30 years after you retire, there are sure to be changes in the market and economy that will need to be accounted for.

If the 4% rule is a guideline for how much you can spend during retirement, you may be wondering how this helps on the saving end of things. The answer is quite simple: you need to have an idea of how much money you’re going to spend in your non-working years so that you know how much you need to save now. This rule helps you work backwards to figure out that amount.

To start, you’ll want to first estimate how much money you’ll spend each year in retirement. Think about any large expenses you may have, such as a mortgage, healthcare costs and medications, groceries and necessities, travel, etc. While this list offers a good place to start, everyone’s expenses will be different as factors such as your health and lifestyle play a huge role. Regardless of how healthy you are, however, healthcare costs are widely underestimated by most people. Additionally, most people don’t think to add a cushion when planning out how much they’ll need. It is a good idea to add an additional $5,000-$10,000 or so to your annual spending for unforeseen circumstances.  

The next step would be to calculate how much you’ll be receiving from benefits, such as Social Security or pensions. The Social Security Administration has an online calculator that can assist you with this. The higher the benefits amount, the less you’ll need to pull each year from your retirement savings and investments.

Now that you’ve got your annual retirement spending figured out, you can use the 4% rule to figure out the total amount you’ll need to have saved up before you exit the workforce. For example, if your annual retirement spending is estimated at $20,000, simply take that number and divide it by 0.04 to get $500,000.00; this amount will last you 30 years if you only withdraw $20,000 (4%) a year. It’s important to also note that if you want to take a more conservative amount and use the 3.3% as your guideline, the amount you’ll need to save will go up.

Next steps to start saving

Now that you have calculated how much you’ll need to save, the next steps are to start saving. There are various calculators out there that can help you determine how much money you’ll need to start with depending on the risk level of the "vehicles” you are using.

One such vehicle option is a 401(k), which may be offered through your employer. With a 401(k), a percentage of your paycheck is automatically invested for you each pay period; just keep in mind that the money being invested is pre-tax, so you’ll owe taxes on the amount you withdraw in retirement. A traditional IRA works the same way, except it is not a company-sponsored account so you would have to set up the account on your own.

There are also post-tax retirement accounts — like a Roth IRA or Roth 401(k) — which allow you to invest money that has already been taxed. Those contributions will grow over the years, and you won’t owe any taxes on withdrawals in retirement.

All of the above investment vehicles carry with them some sort of risk, as they are tied to the U.S. stock market and we all know how volatile it can be. The level of risk is important to take into account, especially if you have already been saving for most of your adult lifetime and are getting closer to retirement. The older you get, the less time you have to make up for any losses due to down markets. For this reason, many people also consider Fixed Index Annuities (FIA) as great savings vehicles for retirement.

Fixed Index Annuities (FIA’s) can be started with cash or from a transfer of your 401(k), IRA, or other account mentioned above (if you’ve already been saving). They have varying levels of time commitments and are backed by insurance companies; as a result, your money is protected during down markets, but grows at a reasonable rate during up-years. We like to say, “Zero is Your Hero,” when it comes to FIA’s, because when others are losing money in their investments you won’t lose money in your FIA.  These accounts can also offer guaranteed lifetime income and some even have long term care benefits, which can help with some of those unforeseen healthcare costs we referenced above.

Regardless of where you are in your retirement saving journey, Summerlin Benefits Consulting can help. We help our clients achieve their unique, individualized retirement goals every day and we do so by laying out options in a simple, easy to understand manner. Retirement planning can be overwhelming and scary, but you don’t have to do it alone. Reach out today for a free consultation!