What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Nest Egg Requirement for Retirement

Original post by Mary Bauer of Demand Media

There is no easy formula to calculate how much you need to save each year for retirement because it depends on several factors, including the age at which you start saving, how well your investments do, income from social security and/or a pension, employer matching funds and any financial obligations you'll have in retirement (such as providing for a parent in a nursing home). Some of these are completely out of your control, so you'll need a little extra cushion for that "just in case" scenario. Experts at Charles Schwab recommend that you aim for a nest egg roughly 25 times the amount of money you think you will spend in your first year of retirement.

Underlying Assumptions

Most on-line savings calculators operate on certain assumptions. They assume that you will want to sustain a standard of living similar to what you enjoy at the time of your retirement, so they calculate that you will need about 80 percent of your annual income, adjusted for inflation. They also assume that your wages or salary between now and retirement will increase at least enough to keep pace with inflation. Most include Social Security allowances in the calculation, but not a pension. If these basic assumptions are incorrect in your case, use a more advanced calculator that allows you to adjust these variables, such as CNN Money's Retirement planner (money.cnn.com).

The Age Factor

The sooner you start saving, the lower the percentage of your earnings you'll need to put into your nest egg account each year. In rough numbers, if you started saving in your 20s, you'll need to put aside 10 to 15 percent of your annual income to reach the standard nest egg goal. If you waited until your 30s, that ratio increases to 15 to 25 percent of your income. Late bloomers who wait until their early 40s need to put aside 25 to 35 percent of their annual income. If you are in your mid-40s or older and you haven't yet started saving for retirement, you most likely won't be able to bank enough to reach this goal, so you may need to plan on working at least part time in your retirement years.

The New Job or Big Promotion

If your income increases substantially, for example with a new job or a significant promotion, you may need to increase the percentage of your income that you save for retirement. That seems shocking, but there are two reasons. First, your expectation for your retirement standard of living will change upward, so you will need more of a nest egg to sustain it, but your earlier savings were a percentage of a lower base pay, so now you have to make up the difference. Secondly, the Social Security system is designed to provide greater assistance to those who need it most. While you will receive a greater monthly Social Security stipend based on your higher earnings, the actual percentage of income you receive from Social Security decreases as your wage earnings go up. You need to set aside more money to make up this difference.

Employer Matching Funds

As a general rule, you can count the funds that your employer contributes to your 401K program as part of your annual savings percentage, but this carries a certain risk. If you change jobs and your new employer doesn't offer a matching funds benefit, you will suddenly have to put aside twice as much as you had previously, which can place a serious strain on your standard of living.

Updating Your Savings Plan

Because many factors that weigh into your retirement planning change over time -- including wages, investment earnings and even the size of your nest egg if you hold stocks -- it's wise to review your retirement savings plan annually. The easiest time is when you've just completed your taxes. You have all the numbers in hand, so take a few extra minutes to plug them into an on-line retirement savings calculator, or make an appointment with your financial adviser. When you reach retirement age, you'll be glad you did.

                   

Resources

References

About the Author

A retired senior federal executive currently working in the health care field, Mary Bauer has written and edited for senior U.S. government audiences, including the White House, since 1984. She holds a Master of Arts in French from George Mason University and a Bachelor of Arts in English, French and international relations from Aquinas College.

Advertisement