Retirement planning involves more than just saving money. You also need to think about how much income you’ll need each year in retirement. Setting retirement income goals is crucial to making sure your nest egg lasts throughout your golden years.
This article provides a complete guide to setting retirement income goals. We’ll cover calculating your expected expenses, deciding on an ideal replacement rate, adjusting for inflation, and choosing a safe withdrawal rate strategy. Follow these steps to determine a realistic target for your annual retirement income.
Calculating Expected Expenses
The first step is tallying up your expected annual expenses in retirement. Make a list of all your current living costs, including:
- Housing (mortgage/rent, property taxes, insurance, utilities, maintenance)
- Food (groceries, dining out)
- Transportation (car payment, insurance, gas, maintenance)
- Healthcare (insurance premiums, prescriptions, out-of-pocket costs)
- Entertainment (travel, hobbies, subscriptions)
- Other (clothing, personal care, gifts, pets)
Now think about how those expenses might change in retirement. For example, your housing costs may decrease if your mortgage is paid off. Healthcare costs likely will increase as you age. Travel expenses could go up if you take more vacations.
Once you have an estimate, don’t forget to adjust for inflation. Most experts recommend planning for an annual inflation rate of 2-3%. Expenses that increase faster than inflation, like healthcare, should be adjusted upwards more.
Choosing a Replacement Rate
Financial advisors often recommend targeting a replacement rate of around 70-80% of your pre-retirement income. This percentage represents the amount of income you’ll need in retirement to maintain a similar standard of living.
A higher replacement rate may be necessary if:
- You have high medical expenses
- You have high housing costs
- You plan to travel extensively
- You support other family members
- You have high debt going into retirement
You may be able to get by with less than 70% if:
- Your mortgage will be paid off
- You’re in good health
- You’ll downgrade your lifestyle
- You have multiple income sources
The average American spends around $46,000 per year in retirement. Think critically about your specific situation when choosing a replacement rate goal.
Factoring in Inflation
One big retirement planning mistake is failing to account for inflation. At an average annual inflation rate of 3%, prices will nearly double in 25 years.
It’s essential to factor inflation into your retirement income plan, especially for long retirements. Here are two ways to build inflation adjustments into your setting retirement income goals:
- Start with your goal income in today’s dollars, then increase it by 2-3% each year leading up to retirement
- Start with your goal income at the time you retire, then work backwards to determine how much you’ll need today
Whichever method you use, make sure your income goal rises over time with inflation. Otherwise, you risk running short of money later in retirement.
Choosing a Safe Withdrawal Rate
Your withdrawal rate is the percentage of your retirement savings you take out each year as income. This spending rate can make or break your nest egg’s longevity.
Financial experts often recommend limiting your annual withdrawals to 4-5% of your portfolio. This creates relatively stable lifetime income even if investment returns are volatile.
However, your ideal safe withdrawal rate depends on:
- Your asset allocation
- Timeframe – higher earlier on, lower later
- Health and longevity expectations
- Other income sources – pensions, Social Security, etc.
- Ability to cut spending if needed
Aim for the highest withdrawal rate possible without too much risk of running out of money. A rate of 3-4% is very conservative, while over 7% is considered risky. Run retirement projections using different rates to find your “retirement sweet spot.”
Sample Retirement Income Goals
Below are examples of retirement income goals for hypothetical couples at various income levels. This illustrates how replacement rates and withdrawal rates apply in real-world situations.
- Current income: $150,000
- Assets: $1.5 million
|Annual expenses||$110,000 (73% replacement rate)|
|Safe withdrawal rate||4% of $1.5 million = $60,000|
|Total income goal||$110,000 from portfolio + $30,000 Social Security = $140,000|
- Current income: $80,000
- Assets: $500,000
|Annual expenses||$60,000 (75% replacement rate)|
|Safe withdrawal rate||5% of $500,000 = $25,000|
|Total income goal||$60,000 from portfolio + $20,000 Social Security = $80,000|
- Current income: $40,000
- Assets: $200,000
|Annual expenses||$32,000 (80% replacement rate)|
|Safe withdrawal rate||4.5% of $200,000 = $9,000|
|Total income goal||$32,000 from portfolio + $10,000 Social Security = $42,000|
- Calculate your expected retirement expenses and adjust for inflation
- Choose a replacement rate based on your individual situation – 70-80% is a common target
- Factor inflation-adjusted increases into your income goal
- Determine a safe initial withdrawal rate – 4-5% is a good starting point
- Run projections annually and be ready to adjust your spending as needed
Properly setting retirement income goals takes careful planning. Follow the steps in this guide to establish a realistic income target that sustains you throughout your retirement years. Monitor your progress and make changes if needed. With the right goals in place, you can retire with confidence.
Retirement Planning: Calculate How Much Money You Need. (2022). Fidelity. https://www.fidelity.com/viewpoints/retirement/how-much-money-do-i-need-to-retire
How to set retirement income goals: 5 easy steps. (2021). Bankrate. https://www.bankrate.com/retirement/setting-retirement-income-goals/
How Much Do I Need to Retire? (2022). AARP. https://www.aarp.org/retirement/planning-for-retirement/info-2020/how-much-money-do-you-need-to-retire.html
Setting Retirement Income Goals. (2021). Vanguard. https://investor.vanguard.com/retirement/planning/retirement-income-setting-goals