A simplified approach to retirement planning revolves around projecting your annual expenses, and then multiplying that amount by 20-25 years to come up with a savings goal. Creating an accurate and itemized list of all expenses expected during retirement is an essential step in responsible financial planning, but the idea of simply multiplying that total by 25 years to arrive at a savings goal is seriously lacking on many levels.
Even if you figure out the optimal savings needed (use a large margin of error when trying to predict the future),
is running out of money in your 90th year your true objective? Of course, you want to be able to pay your bills without worrying, but how will you feel watching your savings balance get closer and closer to $0 every year, unsure if you planned for enough cushion for life's inevitable curve balls? Math is math, but how you will feel about watching your balances decline during all those years of retirement is what so few really pay attention to. You spend 40 years saving, and around half as much time spending those savings. It can be hard, and stressful, to watch your savings continually decline. Not to mention that you may want to leave some money to family members, charity, or other worthy causes. Did you add that into your itemized expenses? Did you account for taxes on 401k/IRA distributions, and possibly on Social Security income, which could easily cost ~15-20% of your total savings?
Rather than just calculating the savings needed to satisfy expenses (i.e., the common, and misguided, recommendation of endless articles about retirement planning), adjust your thinking to calculate the amount of savings needed to generate the income required to satisfy your expenses - with a minimal amount of risk. The planned level of risk is crucial. If you rely on a 7% investment return while working, and it doesn't work out, you can save more and/or work longer to make up the difference. You can't do that if you are retired. You also don't want to expose yourself to high levels of investment risk as you age, with less and less time available to recoup any losses or lower than expected returns. Also, remember that as a savings balance declines, it becomes harder and harder to generate the same amount of returns year after year.
The goal shouldn't be to save the amount that you want/need to spend, it should be to save the amount that will generate the income to pay for what you want/need to spend, while taking the least amount of risk. The difference? Watching your savings balance decline as your expenses get paid or paying your expenses using the income that your savings safely generate, thereby not reducing your principal any more than necessary. It's also a lot less stressful.
Maybe you want to try to preserve all of your principal, or maybe you're okay with spending a good portion of it during retirement. Those are individual choices, but it's the income that your savings will generate, safely and reliably, that will make you feel comfortable and secure. That's one reason why annuities are popular - they guarantee a certain income. But you don't need to pay a huge fee for that, you can create your own annuity. How much income will it take, whether it pays all of your bills or just some (using savings, other income sources, and/or Social Security for the rest), to really be financially secure throughout retirement? And how much money, if any, do you want there to be left when you reach your 90th birthday (or however long you may live)? Those are the real goals that need to be determined. Life can always be counted on to throw you a curve ball (or two, or three...) so do your best to prepare for it both financially and mentally so that you can emerge unscathed. Plan for an income goal that makes you feel comfortable, not just a savings goal to cover your expenses. It's not the same thing.
Below is an example of the savings needed to generate a specific income. To see more details, including how long it will take you to reach these goals, try our free "Years To Income Goal" calculator on the website "Calculators" page.