In the earlier parts of this series, I explained how you should calculate how much income you’ll need in retirement, how much you’ll need to retire, and how much you already have saved for retirement. I’ll be honest. After looking at the second article and realizing what I would have to include in this one, the whole thing was too complicated.

       I want you to actually do this. I want people to have an accurate way to calculate their retirement needs and how much they should save. So I’ve put a lot of work into creating the calculator I’ve included with this post. It doesn’t assume you’ll get the same return every year in the stock market. I’ve used Monte Carlo simulations to account for the fact that stock market returns are variable. Also, it assumes you’ll invest in a diversified portfolio that becomes more conservative as you get older. I’ll explain exactly how you should invest for retirement in an upcoming series of posts.

       Since this calculator simplifies what you need to do, I’m revamping the steps you need to take to calculate how much you should save for retirement. You’re still going to have to do some work, but if you want a good answer you can’t get around doing a little work. Here are the steps followed by the calculator:

1. Figure Out How Much Income You’ll Need in Retirement.

       The first thing you need to know is exactly how much income you’ll need in retirement. This calculator assumes you’ve calculated your retirement income needs in a specific way. To calculate that number, follow the instructions in the first post of this series.

2. Enter Your Current Age.

       Straightforward if you ask me…

3. Enter Your Retirement Age.

       Again, pretty straightforward. Enter the age you’ll be when you want to retire (or think you’ll want to retire).

4. Estimate Your Life Expectancy.

       I realize you don’t know exactly when you’re going to die, but to plan for retirement you need to estimate something. The best way I’ve found to estimate your life expectancy is to use the free life expectancy calculator at Living to 100. This calculator considers your family health history and your own habits to estimate your life expectancy. You’ll also receive tips on how to increase your life expectancy by changing your habits.

       If you’re married, both you and your spouse should use the life expectancy calculator. Then, use the longer of your two life expectancies. Make sure that the difference between the life expectancy you use and the retirement age you used covers the entire time period you or your spouse will be drawing on your retirement portfolio. (For example, you’re 30 and your spouse is 25. You want to retire when you’re 65 and your spouse is 60. Your life expectancy is 85 and your spouse’s is 90. You’ll only need your retirement assets for 20 years, but your spouse will need them for 30 years. Since your spouse will be drawing on your retirement assets for 30 years, you should use a life expectancy of 95 – your retirement age of 65 plus the 30 years your spouse will be alive.)

5. Calculate Your Current Savings after Accounting for Taxes.

       You’ll also need to know how much you’ve already saved up before you can determine how much you should be saving every year for retirement. This is where we’ll account for your taxes. Because we don’t know exactly what changes will happen to the tax structure, we’ll have to estimate this as well. Here’s how to add up each of your accounts (taking taxes into consideration):

• Tax-free Accounts – If you have a Roth IRA or Roth 401(k), you don’t need to worry about taxes. You can include the full value of these accounts in calculating your current retirement savings.

 

• Tax-deferred Accounts – Withdrawals from a Traditional IRA, 401(k), 403(b), 457, or similar accounts will be taxed in retirement. For our purposes, you’ll need to account for the taxes you’ll pay on these accounts. Given our current tax structure, you can plan on paying about 20-25% in federal and state income taxes on these accounts. To figure out how much you should include when adding up your savings, use 75-80% of the account value. If you have $100,000 in your Traditional IRA, you should only use $75,000-80,000 when you’re adding up your savings.

 

• Taxable Accounts – This category includes all your taxable accounts you’re using to save for retirement. It’s a little more difficult to account for taxes in these accounts. You’ll be taxed only on the gain in these accounts. How much of your withdrawals will be taxed depends on your cost basis in these accounts. Since we don’t know exactly what your cost basis will be, we’ll estimate that taxes will be about 15-20% on these accounts. If you know you’ll have a high cost basis, you can adjust accordingly. (If you don’t know what I’m talking about, you probably shouldn’t be investing in a taxable account.) So you’ll want to use 80-85% of the account value when adding up your savings.

       Here’s a quick example. Let’s say you have $25,000 saved in a Roth IRA, $20,000 in your 401(k) at work, and no taxable accounts. You’ll include the full $25,000 in the Roth IRA and 75% of your 401(k), or $15,000. This gives you a total savings of $40,000.

6. Use This Calculator.

       If you’ve followed those first five steps, you’ll have everything you need to use this calculator. After you’ve entered how much income you’ll need in retirement, your current age, your retirement age, your life expectancy, and your current savings, you’ll get an amount you should save this year. Then, increase your annual savings by inflation each year.

*Note: Click the ‘Click to Edit’ button to use the calculator with your own numbers.

       To get a usable answer from this calculator, make sure you’ve followed my instructions. The reason this calculator is so simple is because I’ve built in the assumption that you’ve followed my instructions for calculating everything. So if you think something’s wrong with the calculation, make sure you’ve followed the instructions. (especially on calculating how much income you’ll need in retirement)

       Disclaimer: No guarantee is made that you’ll definitely reach your retirement goals by following the recommendations of this calculator or my articles. This calculator bases its return calculations on the historical risk and return of a diversified portfolio of index funds using Monte Carlo simulations to emulate the variability of the stock market. Past performance is no guarantee of future results, but without a crystal ball it’s the best we have to go on. This information is for education purposes only and does not represent investment advice or an offer of any security for sale.

6. Repeat Every 3-5 Years.

       This calculator works best when you come back every 3 to 5 years, go through the process once again, and get a new number for how much you should save. The reason this is important is because it will consider the changes in your account value that the calculator couldn’t possibly know. So if you have really good results in the stock market, you can save a little less. If not, you might need to save a little more. Just be sure to come back to this calculator every few years until you retire.

Feel Free to Share and Stay Tuned!

       If you’ve found this calculator helpful, feel free to share it with your friends. If you want to learn how to invest for retirement and make sure your asset allocation is correct, sign up for free updates to Provident Planning!

       Once you’ve determined how much income you’ll need in retirement, the next step is to figure out how much you’ll need to have saved up by retirement. Don’t worry. I’m not going to make you do complicated math. If you can multiply, you can figure this out. First, we need to determine how long you’ll be retired.

How Long Are You Going to Live?

       Let’s pull out your crystal ball and figure out how old you’ll be when you die. If you don’t have one, then you’re already aware that we’re only estimating here. There’s no way to know for certain when you’ll take your last breath, but you can plan by taking your health and family history into consideration.

       You can use the free life expectancy calculator over at Living to 100 to estimate how long you’ll live. You’ll even get some tips on changes you can make to live a healthier, longer life. If you’re married, use the longer life expectancy between the two of you.

How Many Years Will You Spend in Retirement?

       Once you’ve estimated your life expectancy, all you need to do is subtract your retirement age from your life expectancy. If you expect to live to age 90 and you want to retire at age 65, you’ll spend 25 years in retirement. Remember that number. You’ll need it in the next step.

How Much Will You Need to Have Saved by Retirement?

       Now for that multiplication I warned you about before. First, you need to know your target retirement income (TRI) from Part 1. Then, using the table below, figure out what number you should multiply by to determine your target retirement savings (TRS). For example, if you’ve determined you need $40,000/year (your TRI) and you’ll be in retirement for 25 years, just multiply by 20 to determine your target retirement savings. In this case, $40,000 x 20 would mean you need to have $800,000 (in today’s dollars) saved by the time you want to retire.

       As I mentioned before, using this chart will tell you how much you need to have saved by retirement in today’s dollars. This isn’t the actual number of dollars you’ll need to have in your account because of inflation, but that doesn’t matter. If you continue to use this process once a year, you can be sure you’re saving enough. Make sure you write down your TRS number. You’ll need it for Part 3 so you can figure out how much you should save each year until retirement.

How Much Have You Already Saved?

       You’ll also need to know how much you’ve already saved up before you can determine how much you should be saving every year for retirement. This is also the part where we’ll account for your taxes. Because we don’t know exactly what changes will happen to the tax structure, we’ll have to estimate this as well. Here’s how to add up each of your accounts (taking taxes into consideration):

• Tax-free Accounts – If you have a Roth IRA or Roth 401(k), you don’t need to worry about taxes. You can include the full value of these accounts in calculating your current retirement savings.

 

• Tax-deferred Accounts – Withdrawals from a Traditional IRA, 401(k), 403(b), 457, or similar accounts will be taxed in retirement. For our purposes, you’ll need to account for the taxes you’ll pay on these accounts. Given our current tax structure, you can plan on paying about 20-25% in federal and state income taxes on these accounts. To figure out how much you should include when adding up your savings, use 75-80% of the account value. If you have $100,000 in your Traditional IRA, you should only use $75,000-80,000 when you’re adding up your savings.

 

• Taxable Accounts – This category includes all your taxable accounts you’re using to save for retirement. It’s a little more difficult to account for taxes in these accounts. You’ll be taxed only on the gain in these accounts. How much of your withdrawals will be taxed depends on your cost basis in these accounts. We’ll estimate that taxes will be about 15-20% on these accounts. So you’ll want to use 80-85% of the account value when adding up your savings.

       Here’s a quick example. Let’s say you have $25,000 saved in a Roth IRA, $20,000 in your 401(k) at work, and no taxable accounts. You’ll include the full $25,000 in the Roth IRA and 75% of your 401(k), or $15,000. This gives you a total savings of $40,000.

       After you’ve figured out how much you’ve saved, you need to determine how much that is as a percentage of your TRS. In the example above, we determined you’d need $800,000 to retire. If you’ve saved $40,000 already, you’ve saved up 5% of your target retirement savings (TRS). (That is, $40,000/$800,000 is 0.05 or 5%.)

       To figure out how much you’ll need to save every year, you need to know your target retirement savings (TRS) and how much you’ve saved already as a percentage of your TRS. In Part 3, we’ll continue to use the example above with a TRS of $800,000 and having 5% of that number already saved up.

       Here’s a quick recap of what you’ve done already:

• 1. Figure out how much income you’ll need in retirement (your TRI).
• 2. Figure out how many years you’ll spend in retirement.
• 3. Multiply your TRI by the appropriate number from the chart above to determine how much you’ll need to have saved for retirement (your target retirement savings or TRS).
• 4. Add up your current savings after accounting for taxes. Then figure out how much that number is as a percentage of your TRS (divide current savings by your TRS).

       In our working example, we decided we need $40,000/year in retirement. We also figure we’ll spend 25 years in retirement. Then, we multiplied our TRI ($40,000) by the number in the chart for 25 years in retirement, which was 20. That gave us a target retirement savings (TRS) of $800,000. Finally, we figured out we have saved up $40,000, or 5% of our TRS, after accounting for taxes.

       To make sure you know what to do next, sign up for free updates to Provident Planning!