Need a number? Try my system to calculate your monthly retirement savings

House sitting on top of money

One of the toughest financial questions 20- and 30-somethings face is: How much should I be saving for retirement each month?

You don't want to save too little and live long enough to regret the decisions you're making today.

But seriously, how can anyone come up with a number you can feel good about when retirement is 25, 35 or even 45 years away?

You can rely on a traditional rule of thumb that says 10% of your gross or pretax income is the number.

Or you can take the advice of major money managers, such as Fidelity Investments, which are saying that's not enough.

They're now advising clients to sock away at least 12%, and preferably 14%, of their income, preferably in a tax-free 401(k) plan or Individual Retirement Account.

Or you can follow the 4 simple steps this dilemma drove me to develop when I was trying to come up with a number I could trust -- and act on.

Step 1. Estimate how much you'll need per month in retirement

Start with you income. You'll want to have an average of how much you make annually throughout your working life.

You might be making $40,000 a year now, but by the time you retire 20 years from now, you might be making $70,000 a year.

So, your average annual income might end up around $55,000 a year.

When you retire, you hopefully will have paid off your house, won't be supporting kids and will have fewer expenses than you do now.

But most experts agree you need to replace at least 60% of your pre-retirement income to continue your lifestyle.

That's $33,000 a year, or $2,750 a month in today's dollars.

But you'll also have to account for inflation, which typically runs 3% a year. So, to have the same purchasing power of $33,000 in 25 years, you’ll actually need $69,000 or $5,750 a month.

Step 2. See how much you can expect from Social Security.

Now that you have an estimate of how much you'll need every month, see how much you might get from Social Security.

Visit the Social Security benefits estimator to estimate how much you'll receive.

It will give you three numbers based on whether you plan to start collecting benefits at age 62, 67 or 70.

The longer you wait to start collecting, the more you'll get per month. If you collect at age 62, you could receive up to 45% less than if you wait until you're 70.

Of course, a lot depends on how much you pay into the system. As your income rises over the next 10, 20 or 30 years, so will your benefits.

You also have to remember that things are a little shaky with Social Security. If you’re under 40, a lot can happen between now and retirement.

There's a good chance they'll raise the retirement age or reduce benefits. They could do both. It’s likely that the system will also pay a smaller cost-of-living adjustment.

Take a look at the four changes that might be in store for Social Security that I recently wrote about.

To be safe, you might want to anticipate receiving 10% less than what's stated on the estimator.

So, if the estimator says you'll receive $3,000 a month when you turn 67, let's change that to a $2,700 monthly benefit.

Step 3. Find your gap and how much you need to fill it

You need to find out how much of a difference you have between what you can expect with Social Security and what you need in retirement.

In the old days, Social Security benefits might have covered most of your needs, but today you’ll be lucky if it covers half.

Sure, you might be able to pinch pennies and scrimp by on your Social Security payment, but is that really how you want to spend your golden years?

In the example above, you’ll need to come up with approximately $3,000 a month of your own money to meet your retirement goal's monthly income.

That's still a lot of money, but it's better than trying to come up with the full amount.

This is when you need to take advantage of the 4% rule.

It says you can take out 4% of your savings the first year of retirement and the same amount, adjusted for inflation, each year after that.

In theory, your money should last 30 years.

Using the 4% rule, to come up with $3,000 a month or $36,000 a year, you’ll need to have $900,000 socked away.

That’s a whopping number, but remember you have 25 years to reach that goal. And even if you don’t meet it (you likely won’t), you’ll still want to come as close to that number as possible.

It won’t be the end of the world if you don’t make that number.

Since Social Security will be covering almost half of your retirement income, failure to make that goal will have a smaller impact than you might imagine.

Say you only end up with $600,000 by the time you retire. That’s a whopping 33% less than you were aiming for, but it will only represent about a 16% reduction in your retirement income.

In any case, you want to get as close to your goal as possible. Saving regularly, often and early can help you grow your nest egg through compounding.

Step 4: Work backwards to figure out how much you need to save each month.

Finally, take that big number and deduct for any retirement savings you already have. So, if you have $40,000 socked away already, you’ll aim to put away $860,000 by the time you retire.

If you have 25 years to go and assume that your fund will grow at the historical stock market average of 8% a year, you’ll need to put away $7,500 a year.

That’s $625 a month.

Of course, all of these variables could change, especially your return.

If you socked away $625 a month and averaged a 9% return, you’d end up with over $1 million. Or you'd have $724,000 if you averaged only 7%.'s Savings Goal Calculator makes these kind of calculations easy.

Just remember that a lot of things can change over the years, but you need to have a target to work with.

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