How to Determine the Amount Needed when Saving for Retirement

How much money would you like to have when you retire? Most of us have and idea of how much money we would like to have. But in reality, very few people know exactly how they will get there. It is important to determine how much money you need to be saving each month now, in order to reach your goal at retirement.

At Dave Ramsey's Financial Peace University class, I learned that some simple math can help you determine exactly how much you need to be saving now to have your desired nest egg at retirement. And the sooner you begin, both planning and saving, the easier it will be to reach your goal.

The first step is to determine what you would like your annual income to be at retirement, in today's dollars. You might start by thinking about how much your monthly expenses will be, taking into consider whether your home will be paid off. Most people question how long social security will be around, so make your determination without relying on that income. For our example, let's say you would like to retire on an annual income of $50,000.

So, we want to determine how much we need to be saving now in order to retire with an annual income of $50,000. Our plan will be to invest our monthly savings with an interest rate of 12%. We will assume an inflation rate or 4%. So, our net interest rate will be 8% per year. Basically, we will want our nest egg of a sufficient amount so that we can live on the yearly interest it generates. In our example, we will want the 8% interest to equal $50,000 per year. So, to determine this amount you will divide 50,000 by .08. This equals 625,000. So, if you had a nest egg of $625,000, and you were earning an interest rate of 8% (after inflation), you would earn $50,000 each year in interest. This $50,000 would be your retirement income. And assuming that you continued to earn a net interest rate of 8%, and you lived only on the $50,000 interest, never dipping into the principle, you would continue to earn $50,000 for the rest of your life. In this way, you would not have to worry about outliving your retirement money, which is pretty terrific!

Now we need to determine how much you need to be saving each month now to achieve your nest egg of $625,000 by retirement. This will depend on how old you are now and at what age you would like to retire. To determine the monthly amount you need to be saving for retirement now at 8% interest, determine the 8% factor that corresponds to the number of years you have to save.

Years
To Save Factor
40 .000286
35 .000436
30 .000671
25 .001051
20 .001698
15 .002890
10 .005466
5 .013610

So, you will take the amount of the nest egg you want and multiply it by the appropriate factor. For our example, let's assume you are 40 years old and you would like to retire when you are 65. So, you have 25 years to save. You would multiply $625,000 (the amount of our desired nest egg) by .001051 (the 8% factor that corresponds to having 25 years to save). This equals $656.88, which is the monthly savings that would be required to have $625,000 at retirement.

Knowing how much you need to save is the first step towards reaching your goal. You could say that doing the math was the easy part, now you need to do the hard part and get serious and begin saving now! The longer you wait to start, the more you will need to save in order to reach your goal.