Years ago, retirement income was often pictured as a three-legged stool. One leg was Social Security benefits, another was employer pensions, and the third was savings.

A lot has changed since those days. Many of us no longer have traditional employer pensions, leaving us with a wobbly, two-legged stool. What's more, because of today's rising life expectancies, those two legs may have to support us for a much longer period of time—three decades or more in many cases.

One thing hasn't changed, however. The question of how much retirement income is "enough" doesn't lend itself to a one-size-fits-all answer. It depends on many factors, most notably your future retirement expenses, to the extent that you can predict them.

Key Takeaways

  • To know if you'll have enough income in retirement, try to estimate your future expenses, based on what you spend now.
  • In addition to your Social Security benefits and traditional pension (if any), you can probably spend about 4% of your savings each year.
  • If your income won't be adequate to cover your expenses, ask yourself how you can raise the one, reduce the other, or both.

Predicting How Much You'll Spend

There are a variety of formulas for estimating your retirement expenses, all of which are rough guesses at best. One well-known rule of thumb is that you'll need about 80% of the amount you're spending shortly before retirement. That percentage is based on the fact that some major expenses will go down in retirement (commuting costs and retirement-plan contributions, for example). Of course, others may go up (vacation travel, for example).

What retirees often report, though, is that their expenses in the first few years not only equal but sometimes exceed what they spent while they were still working—in part because they simply have more time to go out and spend. Many retirement experts also note that retirees' expenses often go through three distinct phases: higher spending early on, more modest spending for a long period after that, and higher spending near the end of life, due to medical or nursing home expenses.

Much of this is unpredictable, of course. But the closer you are to retirement, the better an idea you probably have of how much money you'd need to sustain your current standard of living. If you use that as a base, subtract any expenses you expect will go away after you retire, and add in any new ones, you'll have at least a ballpark figure to work from. If you anticipate any big bills (a lot more travel, a brand new kitchen) be sure to count those in, too. Same for any major cost-savers (such as if you plan to downsize and move to a less-expensive home).

Many retirees find they spend the most money in the early, and final, years of retirement.

Adding Up Your Income

Now that you have some notion of your retirement expenses, the next step is to see whether your income will be adequate to cover them.

Returning to that two- or (if you're lucky) three-legged stool, first add up how much income you expect to receive from Social Security and any traditional, defined-benefit pension plans.

Social Security. If you've been working and paying into the Social Security system for at least 40 quarters, or 10 years, you can get an projection of your Social Security benefits by using the Social Security Estimator at ssa.gov. The closer you are to retirement, the more accurate the estimate is likely to be. Bear in mind that the earlier you take benefits, the less you'll get each month. You can opt to take benefits as early as age 62 or as late as age 70, after which there's no further incentive for waiting. You can run various retirement-age scenarios on the Social Security website.

If you have a pension coming to you from your current employer or a former one, the plan's benefits administrator can give you an estimate of how much you'll be eligible to receive when the day comes. If you have a spouse, you will want to consider your likely income under different arrangements, such as taking benefits in the form of a joint and survivor annuity, which will continue to provide a specified percentage of your benefits to your spouse if you die first.

That leaves the remaining leg of the proverbial stool, the income you can expect from your savings.

Your retirement savings. How much income can you count on from your IRAs and other retirement accounts? Many financial advisors boil the answer down to one number, at least as a starting point: the 4% sustainable withdrawal rate. Essentially, this is the amount you can theoretically withdraw through thick and thin and still expect your portfolio to last at least 30 years, if not longer. Not every expert today agrees that a 4% withdrawal rate is optimal, but most would argue that your rate probably shouldn't exceed it.

To illustrate, suppose you manage to save $1 million by the time you begin to think seriously about retiring. Under the 4% rule, you could take $40,000 a year in income from your retirement accounts, with a small adjustment each year for inflation. If you had $2 million saved, the amount would be $80,000 a year; if you had $500,000, it would be $20,000.

Your Personal Bottom Line

So, after you add it all up, if your total retirement income exceeds your predicted expenses, you probably have "enough" for retirement. It wouldn't hurt to have more, of course.

But if it looks like you're going to fall short, you may need to make some adjustments and find ways to increase your income, lower your expenses, or both. That might mean, for example, working for a few more years if you're able to, boosting the portion of your pay that you're putting away for retirement, or adopting a more frugal lifestyle even before you retire.

The sooner you do the math, the more time you'll have to make the numbers work in your favor.

Can I Just Shoot for $1 Million?

Can you retire with $1 million? Of course you can. Truth be told, you might be able to retire with much less. Then again, you might not be able to retire with $1 million or $2 million or perhaps even $10 million. It all depends on your personal situation and, in particular, your spending.

For that reason, financial planners often have very different advice for clients who are trying to decide if they are in a position to retire:

  1. "Of course you can retire! Live it up and enjoy!" If you are at least in your 70s with reasonable expenses, there is a good chance you and your $1 million fall into this category.
  2. "The probability for your retirement looks good. Just don't go crazy and buy a Porsche." If you are at least 62 and have always lived a frugal lifestyle, then you and your $1 million are likely going to fall in this category.
  3. "Let's redefine retirement for you." This is just about everyone else, including early retirees with $1 million living frugally and 70-year-olds with $1 million spending lavishly.
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Nashville: How Do I Invest for Retirement?

$40,000

If you are 65 with $1 million in savings, you can expect your portfolio of properly diversified investments to provide $40,000 per year (in today's dollars) until you are 95. Add that to your Social Security income, and this is how much you could expect to bring in per year in retirement.

Now, if taking $40,000 a year from your investments isn't enough for you to maintain the lifestyle you want, you have come to your unfortunate answer rather quickly: No, you cannot retire with $1 million. Ditto if you have $2 million saved and need more than $80,000 of it each year, or if you have $500,000 and you hope to withdraw more than $20,000.

Now wait a minute, you say, what about my spouse, who is also getting Social Security? What if I'm 75, not 65? What if I want to die broke? What if I'm getting a government pension and benefits? What if I'm planning to retire in Costa Rica? There are many "what ifs," but the math is still the math: if you plan on needing a lot more than $40,000 from your retirement nest egg, then the probability of a successful retirement on $1 million is not good.

"If you’ve only saved $1 million and are withdrawing 4% or more in retirement, you are most likely tempted to expose your accounts to more risk to make up for the lack of savings. With more exposure to a volatile market, there is a greater chance your retirement accounts will incur substantial losses during market corrections," says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

And early retirement, meaning before Social Security and Medicare kick in, is extra risky, in part because your retirement investments will have to support you for even more years.

"People do not plan properly for income in retirement because they don’t really think about Social Security properly, they compartmentalize their assets, they don’t think about how everything they own can create income, they fail to appreciate the power of leverage in retirement. It is not especially risky to have just $1 million in retirement assets if you own things that can be turned into retirement income," says Tracy Ann Miller, CFP®, CEO and chief portfolio officer, Portfolio Wealth Advisors, Oklahoma City, Okla.

Spending and Expenses

"Often pre-retirees credit themselves with more control over spending than is realistic. Life’s wants quickly become needs. Rather than despair over spending more than you predicted, I suggest saving more to provide a reserve for these and other unforeseen contingencies," says Elyse Foster, CFP®, founder of Harbor Financial Group in Boulder, Colo.

Savings Rates: What's Enough?

Let's look at the retirement-money issue another way: not in terms of how big a sum you should have, but how much you should be socking away annually.

Ten percent is the historical recommended savings rate. However, there is an extreme mismatch between this optimal savings rate and the actual savings rate among Americans today. According to the St. Louis Federal Reserve Bank, and other reports, the U.S. consumer's savings rate is less than 5%.

Let's look at how these assumptions could play out for a future retiree.

5% Retirement Savings Rate

We'll start with how saving 5% of your earnings during your working life would play out when it's time to retire. 

Let’s assume that Beth, a 30-year-old, makes $40,000 per year and expects 3.8% raises until retirement at age 67. Further, with a diversified portfolio of stock and bond mutual funds, Beth expects a return of 6% annually on her retirement contributions. 

With a 5% savings rate throughout her working life, Beth will have $423,754 saved up (in 2051 dollars) at age 67. If Beth needs 85% of her pre-retirement income to live on and also receives Social Security, then her 5% retirement savings are significantly short of the mark.

To match 85% of her pre-retirement income in retirement, Beth needs $1.3 million at age 67. A 5% savings rate doesn't even place her savings at 50% of the funds she'll need.

Clearly, a 5% retirement savings rate isn’t enough.

10% and 15%

Keeping the above assumptions about her salary and expectations, a 10% savings rate yields Beth $847,528 (in 2051 dollars) at age 67. Her projected needs remain the same at $1.3 million. So even at a 10% savings rate, Beth misses her preferred savings amount.

If Beth pumps up her savings rate to 15%, then she reaches the $1.3 million (2051) amount. Adding in anticipated Social Security, her retirement will be funded.

Does this mean that individuals who don’t save 15% of their income will be doomed to a sub-standard retirement? Not necessarily.

Conservative Assumptions

As with any future projection scenario, we’ve made certain conservative assumptions. Investment returns might be higher than 6% annually. Beth might live in a low-cost-of-living area where housing, taxes, and living expenses are below the U.S. averages. She might need less than 85% of her pre-retirement income, or she may choose to work until age 70. In a rosy case, Beth’s salary might grow faster than 3.8% annually. All of these optimistic possibilities would net a greater retirement fund and lower living expenses while in retirement. Consequently, in a best-case scenario, Beth could save less than 15% and have a sufficient nest egg for retirement.

What if the initial assumptions are too optimistic? A more pessimistic scenario includes the possibility that Social Security payments might be lower than now. Or Beth may not continue on the same positive financial trajectory. Or, Beth might live in Chicago, Los Angeles, New York or another high-cost-of-living region where expenses are much higher than in the rest of the country. With these gloomier hypotheses, even the 15% savings rate might be insufficient for a comfortable retirement.

Measuring Your Needs

If you've reached mid-career without saving as much as these numbers say that you should have put aside, it's important to plan for extra savings or income streams from now on to make up for the shortfall. Alternatively, you could plan to retire in a location with a lower cost of living, so that you will need less. You can also plan to work longer, which will augment your Social Security benefits, as well as your earnings, of course.

If you're looking for a single number to be your retirement nest egg goal, there are guidelines to help you set one. Some advisors recommend saving 12 times your annual salary. Under this rule, a 66-year-old $100,000 earner would need $1.2 million at retirement. But, as the former examples suggest—and given that the future is unknowable—there is no perfect retirement savings percentage or target number.

The Need to Plan

Instead of thinking in terms of specific nest egg amounts like $1 million or savings rates, your first step in planning is determining how much you'll need.

Many studies indicate that retirees will need between 70% to even 100% of their pre-retirement income to maintain their current standard of living.

A reasonable savings target is one that will provide you with an annual income similar to the income you have now. Then you need to consider a "safe" withdrawal rate. This is the percentage of your retirement nest egg you will withdraw each year during your retirement. As noted above, 4% is the traditional benchmark figure, but 5% to 6% might be more realistic. This provides a quick and dirty formula for determining the total amount you need to save by retirement: divide your desired annual income by the withdrawal rate.

Nest-Feathering Factors

When calculating your target nest egg, and how much you have to save each month to reach that target, there are many factors that come into play:

  • Your current age.
  • Intended retirement age.
  • Life expectancy.
  • Current earnings.
  • Income sources during retirement.
  • Amount of current retirement savings.
  • Expected savings contributions.
  • Cash outflows during retirement.
  • Portfolio risk/return.
  • Inflation.

Of all of these, perhaps the third-to-last is the most important – or at least, the most controllable. "Having a firm grasp on your living expenses is critical to retirement success. It is far better to understand your situation when you can be proactive and make adjustments, rather than waiting for a crisis to erupt and being forced into action. As it is said, 'an ounce of precaution beats a pound of cure,'" says Jack Brkich III, CFP®, founder of JMB Financial Managers, Inc., in Irvine, Calif.

Once you have an idea of how to determine how much you need, it's time to start using the tools available to you. Today, those defined-benefit plans have become virtually extinct, shifting the burden of retirement savings away from corporations and onto the employees. So bone up on the tax-advantaged benefits of 401(k) plans, IRAs and Roth IRAs, and figure on how to maximize their use.

No one knows the future or what savings rate is enough. Nor do we know our eventual investment returns. But savers can control how much they save – and understand how returns compound. Because of the magic of interest generating interest, the earlier you start, the less you'll have to save on a monthly basis.

The Bottom Line

Clearly, planning for retirement is not something that you do shortly before you stop working. Rather, it's a lifelong process. Throughout your working years, your planning will undergo a series of stages in which you will evaluate your progress and targets and make decisions to ensure you reach them. 

A successful retirement depends largely not only on your own ability to save and invest wisely but also on your ability to plan. Remember, stuff happens in life. Do you really want to start this 30-plus year adventure with the bare minimum? Just getting by isn't a good way to start decades of unemployment and diminishing employability. If something unexpected happens, what are your options? Re-enter the workforce, change your lifestyle or get more aggressive with your investments? This is the equivalent of doubling down in blackjack: it can work, but we wouldn't bet on it – more than once.

"Retirement should be a change of occupation, a chance to do what you want to do. We all only have so much time to do something until our bodies fail us and we can do less and less," says Wes Shannon, CFP®, founder of SJK Financial Planning, LLC, in Hurst, Texas. How much income you'll need in retirement is hard to know, and tricky to plan. But one thing's for sure: It's much better when you are over-prepared than when you wing it.