Step 3: What Will It Cost? Some say you will need 60% to 85% of your gross household income today to sustain the same lifestyle after you retire. In theory, the higher your income today, the closer you are to the lower end of that scale. However, it is recommended to look at this issue in a slightly different fashion.

Sure, we could sit down to a long, drawn-out process in which we look at our expenses and try to anticipate what they would be in retirement. Why bother? After all, retirement is a long way off, and we have no real idea of what those expenses will be then. You do, though, know that you live comfortably today and that it is unlikely you will be saving money or paying FICA (unless you choose to work) after you retire. Therefore, excluding those items from your gross income, you can come up with a number that is fairly close to what it would take to sustain your current lifestyle.

People want a retirement income that equals our gross income today less all savings and all FICA taxes.

However, you still have to decide what income you will need in retirement to live the way you want. Some folks can get by on much less than they use now, while others may decide they want more. It is a personal choice for all of us.

Now, let's talk about inflation. How much does our retirement savings have to be in the year we retire after it has been adjusted for inflation over the years between now and then? What should that inflation rate be anyway? (Use one of our calculators to see how much your savings will be worth years from now.) For how many years will we draw that income? Should it keep pace with inflation throughout those years? Will we draw down our starting retirement portfolio to support our income needs or just live off the earnings while never touching the principal? If we can answer those questions, then we can determine the starting portfolio we need at retirement to support us for the rest of our lives.

We are getting into the realm of some pretty sophisticated calculations based on several assumptions that, if changed, could radically alter our results. What we need is a quick-and-dirty way to give us an idea of what we need to do to get started. We will save the more complex calculations for later.

So forget about inflation for the moment. Ignore Social Security and any company pension you may get. Pretend your money gets no return now or after retirement, but do count whatever you have saved for retirement as of today. Let's say that amounts to $20,000. Further, let's say you want an annual income of $30,000 in today's dollars after you retire, that you will retire in 25 years, that you will live 20 years after you retire, and that you expect to meet your maker waving your last dollar bill.

How much do you need to amass by the start of your retirement to support yourself in your golden years, and how much do you have to save each year between now and then to get there?

You need $30,000 a year for 20 years, so that comes to $600,000 needed in the first year of retirement. You already have $20,000 of that, so that means you are only $580,000 short. Divide the shortage by the 25 years you have to save it up, and you discover you only have to cough up $23,200 annually between now and the time you retire to a life of leisure.

Too much is omitted from this simple approach to provide a meaningful answer to the question at hand. Worse, the answer we do get makes the whole idea of saving for retirement seem to be an impossible task, but this is far from true.

To do things right, we must take a cold, hard, objective look at our desired income, subject it to a rational choice of assumptions, and make some detailed calculations. The best way to do the calculations is with one of the readily available software packages available commercially, such as Quicken Financial Planner or one of our Retirement Calculators. Before you use any of these tools, you need some preliminary information. At a minimum, you want to:

1. Decide on the annual income you desire in today's dollars.
2. Pick a retirement date.
3. Determine your lifetime average inflation rate.
4. Determine the average rate of return you expect on your investments before and after retirement.
5. Determine the current market value of all your investments to include regular accounts, IRAs, and company tax-deferred savings plans like 401(k) plans.
6. Obtain an estimate of any company-provided pension benefit.
7. Obtain an estimate of future Social Security benefits (see Step 7: Social Security).