We're all going to retire, and that means we're all going to need some money put aside for retirement. The problem is that when we think broadly about saving for retirement, it seems impossible. A million dollars? More? How are we going to possibly come up with that kind of money?
Here's the catch: None of those retirement articles out there – the ones that talk about having to save millions – are writing about your situation. Instead, they're writing about someone else, often someone earning a lot more than you.
What you need is a plan that works for you, and that starts with having a good target number for retirement savings.
To calculate your retirement number all you need is your most recent Social Security statement along with how much you made in the past year as well as the number of years between now and when you plan to retire. You'll also need a web browser with Google ready to go and a piece of scratch paper.
Step 1. The first thing you need to figure out is what your current salary will look like when you retire because this whole plan is based on the idea that you'll live on your current income when you retire. If you plan on living on 80 percent of your salary or another percentage, head to Google right now and type in "80 percent of $40,000" or whatever your current salary is. I usually suggest people use 80 percent of their salary for their retirement number because they will no longer have work-related expenses.
Step 2. Expect that long-term inflation will be 3 percent, which is based on a high-end estimate from the Federal Reserve.
So, you should go to Google and type in "1.03^" followed immediately by the number of years between now and when you expect to retire. So, if you expect to retire in 18 years, you'd type in 1.03^18.
Now, take that number and multiply it by your salary (or whatever you decide to use above). If you're using Google, a calculator should appear with the first number already entered for you. If you were using $32,000 per year (80 percent of $40,000) and you're retiring in 18 years, for example, it will give you $54,477, which is what your salary will look like in 18 years with normal inflation.
Step 3. From that number, you need to subtract what you'll receive annually from Social Security, so pull out your Social Security statement and look for your annual benefit. Subtract that from your salary above. In this example, a person might have an annual benefit of $15,000 from Social Security, so his or her new number would be $39,477.
Step 4. Now, that annual amount is going to have to last you for awhile. I usually assume people will spend an average of 25 years in retirement, but their investments will continue to earn a return while they're retired. So, I tell people to multiply that salary number by 20, which is your final step.
Therefore, a person who makes $40,000 per year and is 18 years from retirement needs to save $789,540 for retirement.
This is a quick calculation, of course, but saving enough to hit your number is not as scary as you might think, particularly if you're far from retirement. This person, who receives a 1:1 employer match on his or her 401(k) up to 6 percent, and hits all of that while also fully funding a Roth individual retirement account each year, would be close to on pace for that number. Someone starting to save earlier might not even have to push that hard. Someone starting later might have to save even more or consider waiting a year or two longer to retire.
The lesson of this story is simple: Start saving now. You're going to need quite a bit of money to retire, and every year you put it off the harder you make your savings journey.
Trent Hamm is the founder of the personal finance website TheSimpleDollar.com, which provides consumers with resources and tools to make informed financial decisions.