Working out how much money you need to save for retirement is not an easy task. There are a number of variables that need to be considered.
For example, you need to work out what age you plan to retire and roughly how much you plan to spend per year in retirement. Are you planning to enjoy a luxurious retirement that includes holidays abroad, or keep things simple and live cheaply? How long do you expect to live? What will inflation rates be? These are just some of the factors that need to be considered.
Today, I'm looking at two retirement calculator 'rules of thumb'. These could potentially help you calculate a rough estimate of the amount you'll need for retirement.
The multiply by 25 rule
The multiply-by-25 rule (also known as the 4% rule) estimates how much money you'll need to save for retirement by multiplying your desired annual income by 25.
If you plan to spend £30,000 per year in retirement, you'll need to save £750,000. If you plan to spend £40,000 per year, you'll need £1m.
As to how much you may spend, Which found last year that households on average spent around £26,000 per year in retirement. This included all the basic areas of expenditure and some luxuries such as trips to Europe, hobbies and dining out. Using the multiply-by-25 rule, you would need to save £650,000 to live this lifestyle.
If you plan to take long-haul trips around the world and upgrade your car every few years, you may need closer to £39,000 per year and would, therefore, need to save £975,000.
The multiply-by-25 rule does have its flaws. It doesn't take into account any other sources of income you may have such as rental income, or access to state benefits. It also makes assumptions that your capital will continue to be invested after retirement and that future returns will look similar to returns we have seen in the past. It's not perfect as a retirement calculator rule, but it's helpful as a rough guide.
The savings factor rule
Another helpful retirement calculator rule is the savings factor rule, developed by US investment manager Fidelity. This rule can help you track where you are on your journey to retirement. Simply multiply your income by one of the factors below, depending on your age.
For example, by age 40, you should aim to have three times your salary at that age saved for retirement. If your salary is £40,000 at age 40, you should aim to have saved around £120,000 for retirement by then. By age 55, you want to have saved seven times your salary. If your salary is £55,000 at 55, aim to have £385,000 saved for retirement.
This rule assumes a retirement age of 67. It also assumes that 15% of your income is saved every year from the age of 25 and that at least 50% of your savings are invested in stocks over your lifetime. Again, it's not a perfect rule, but helpful as a rough retirement calculator guide.
Do you want to retire early and give up the rat race to enjoy the rest of your life? Of course you do, and to help you accomplish this goal, the Motley Fool has put together this free report titled "The Foolish Guide To Financial Independence", which is packed full of wealth-creating tips as well as ideas for your money.
The report is entirely free and available for download today, so if you're interested in exiting the rat race and achieving financial independence, click here to download the report. What have you got to lose?