Here is a quick three-step methodology you can use to determine how much money you need to save for your retirement:
1. Estimate your annual retirement expenses and income.
2. Determine the size of your retirement nest egg.
3. Determine how much you must save and invest each month to achieve your nest egg.
What are your retirement expenses and income?
Estimate your annual expenses (housing, car, medical, insurance, taxes, food, debt payments and other). Be sure to include the effect of inflation on your expenses. For example, a three percent annual inflation rate causes your expenses to double in 24 years. So if you require $50,000 now, you would need $100,000 in 24 years.
How much money will you need in your retirement nest egg?
After you retire, you will use your retirement nest egg to pay bills and medical expenses and take vacations. To ensure that you never run out of money during retirement, your annual dollar withdrawal should equal the amount of money you add to the nest egg from interest and dividend payments and capital gains. If the dollar amount added each year is equal to or exceeds the amount that you withdraw, your principal will never fall. And it could increase.
The following simple formula computes the dollar amount that you must accumulate to ensure a stable nest egg:
Nest Egg Dollar Amount = Annual Dollar Withdrawal / Rate of Return on Nest Egg
For example, at a five percent return on your nest egg you would need to accumulate $400,000 to withdrawal $20,000 forever without reducing the value of the nest egg.