An essential part of retirement planning is knowing how much you need to save during your working years to be able to live comfortably later. And while it is easy enough to project an exorbitant amount, say, a billion dollars, it’s not really a realistic goal for most people. This article discusses seven crucial considerations for determining the ideal retirement income.
Key Considerations For The Ideal Retirement Income
What’s enough for a comfortable retirement is relative to each person. It will depend not only on your targeted lifestyle in retirement, inflation, healthcare needs, and longevity, but also on your current financial and living situation. Consider the following:
1. Desired Lifestyle In Retirement
This is the most important factor. You need to clarify to yourself how you want to live in retirement. This helps you determine your baseline needs and discretionary expenses to prepare for.
For example, think about your desired housing arrangement. Do you want to stay at your own house or live in a retirement home? Perhaps you want to move to another city or leave the U.S. altogether. This might seem simple enough but your housing arrangement alone will affect your retirement lifestyle. It will determine your baseline for utility, food, transportation, and even healthcare costs.
You also need to consider your discretionary expenses. Do you plan on travelling? What other activities or hobbies will you spend your time on? Will you be supporting just yourself or do you want to engage in philanthropy? Will your standard of living rise or fall as you have more free time? Your desired lifestyle decides your monthly income needs.
2. Pre-Retirement Income Replacement Rate
This refers to the percentage of your pre-retirement earnings that should be replicated by your retirement income to maintain your current standard of living. While the ideal figure varies, most experts recommend between 70% and 80% of your average annual income immediately before retirement. The percentage is less than your actual income because certain expenses like payroll taxes, retirement contributions, and work-related commuting, among others, either decline or disappear in retirement, reducing your overall cash flow needs.
Of course, there will be certain adjustments based on other factors. For example, if you can get out of debt before retirement, you may need less than 70% of your pre-retirement income as you are essentially freeing resources for other expenses. Conversely, if you anticipate high medical costs or if you have ongoing financial obligations to family members, your replacement rate may need to be more than 80%.
Your current lifestyle and cash flow is a useful guide for your ideal retirement income. It can help you estimate your future income needs based on your accustomed standard of living.
3. Longevity Risk
This refers to the risk of outliving your retirement funds. This is why you should aim to have retirement income or savings that well exceed current life expectancy. For reference, the average life expectancy in the U.S. is 74.8 years for males and 80.2 years for females based on latest data from the CDC National Center for Health Statistics.
With advancements in medical care and depending on how well you take care of yourself, it is entirely possible to live longer than these averages. It is best to plan to have retirement income up to your 90s. Better have it and not need it. Besides, you can always pass on your savings and other assets to your heirs or other beneficiaries through a well-constructed estate plan.
Never underestimate your lifespan and risk depleting your funds too early. You don’t want to be a burden on your loved ones.
4. Inflation And Purchasing Power
Inflation is the general rise in the prices of goods and services in an economy. Even modest annual inflation can substantially reduce your purchasing power over time. For example, assuming an average inflation rate of 2% per year, the value of a fixed retirement income will be reduced by 40% in 25 years. That is, $50,000 in purchasing power today would be worth approximately around $30,000 in real terms in the final years of your retirement.
You should also consider that healthcare costs tend to rise faster than the general inflation rate. For example, an analysis by the Peterson-KFF Health System Tracker showed that in 2024, medical costs rose by 3.3%, higher than the overall inflation rate of 3.0%. This is a crucial point, since you expect to increase healthcare spending as you grow older.
As such, your ideal retirement income should not only be large enough, it should keep pace with inflation. Consider incorporating inflation-sensitive assets and income sources, such as equity investments, Treasury Inflation-Protected Securities, real estate, and dividend-growing stocks. You may also look into inflation riders in certain annuities.
5. Tax Efficiency
While you might want to reach a specific gross income target, you should focus on after-tax income, which reflects the actual dollar amount available to spend. The structure of your retirement assets and the sequence in which you draw upon them can produce different tax outcomes with significant effects on your lifestyle and the funds’ sustainability.
You should understand your retirement income sources and their tax treatment. For example, if you have traditional accounts like a 401(k) or IRA, your withdrawals will be taxed as ordinary income. In contrast, if you have Roth accounts, you will have tax-free withdrawals since you funded them with after-tax dollars. Additionally, if you have taxable brokerage accounts, you might have some flexibility, since long-term capital gains are generally taxed at a lower rate than ordinary income. You should also consider the implications of required minimum distributions (RMDs) on some of your retirement accounts, especially after age 73.
A common strategy is to withdraw first from taxable accounts, then tax-deferred vehicles, and last from Roth accounts. This can potentially reduce future RMD burdens, preserve tax-advantaged growth, and moderate annual tax exposure. Consult a tax attorney or expert financial advisor for more information and tailored advice.
6. Government Benefits
Social Security and Medicare are the backbone of retirement income for most retirees in the U.S. For example, according to data from the Social Security Administration, Social Security benefits form over 30% of retirement income for Americans 65 or older, with 51.8 million retirees receiving an average of $1,975 per month. Similarly, Medicare provides crucial support for healthcare expenses, where 90.1% of all its beneficiaries are over 65 years old, based on recent data from the Centers for Medicare and Medicaid Services.
These benefits are a major boost to your retirement income. While they alone can’t support a comfortable retirement, they can reduce the burden on your personal savings, especially if you integrate them strategically with withdrawals from your retirement accounts and other income sources.
7. Emergency Fund
Another crucial consideration is having an emergency fund. While it should not be part of your retirement income, it gives you security and peace of mind, knowing that you do not have to derail your spending plan if emergencies happen.
While you are still employed, you should save at least six months’ worth of living expenses into a separate account. This fund should only be used for emergencies such as car repairs or unexpected medical costs. Without an emergency fund, you might be forced to dip into your tax-advantaged accounts ahead of schedule, or claim Social Security benefits before full retirement age, which can derail your retirement plan.
Remember to always replenish your emergency fund whenever you dip into it so you have enough reserves the next time you need it. Having an emergency fund is not optional when securing your ideal retirement income.
Final Thoughts
There is no one-size-fits-all amount that can guarantee a comfortable retirement. Nonetheless, if you plan based on the considerations above, you can almost certainly achieve your retirement goals. Start early and consult a financial advisor for personalized guidance. Or, if you have a billion dollars, then you’re probably set.
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