How much of a nest egg you need at retirement depends on several factors specific to your financial situation. The biggest factor is how much of your retirement income needs to come from that egg. If you have a pension, as well as Social Security, your nest egg will be for supplemental income and big expenditures. Without a pension, you need enough set aside to provide enough income for the rest of your life. A couple rules-of-thumb will help with the initial planning.
Retirement Income Sources
After you retire, there will no longer be a steady paycheck, and your income will come from the sources cultivated during your work career. Social Security provides a base level of income. If you will receive retirement pension from you employer, you will have an additional stream of income. Your retirement savings -- your "nest egg" -- would be another source of income through regular withdrawals from your retirement accounts. Look at your current income, project how much you will need in retirement and calculate what portion of your retirement income will come out of the nest egg.
The 4 Percent Rule
Financial planner Bill Bengen developed the 4 percent retirement withdrawal rule in the 1990s, which has become a widely used rule-of-thumb. The rule says annual withdrawals of no more than 4 percent should allow a balanced investment portfolio to last for a full retirement. To determine the size of the needed nest egg, divide the income you need from your savings by 4 percent -- 0.04. For example, if you want to get $25,000 per year from your retirement account, the account should be worth at least $625,000 when you retire.
Multiple of Final Income Rule
Fidelity Investments has developed retirement savings guidelines based on your final income before retiring. The assumption is that the nest egg amount must be enough to replace 85 percent of your pre-retirement income. The guidelines say your savings should be at least eight times your final working annual income to retire at age 67. The challenge for this calculation is to estimate your level of income in those final years before retirement. If you are years away from retiring, your income will probably grow significantly, as will the size of your projected nest egg.
Saving for Retirement
The key to having a big enough nest egg when you retire is to start saving for retirement as soon as possible. Contributing to an IRA or an employer-sponsored 401(k) provides tax-deferred earnings which -- if given enough time -- will provide the retirement sum you will need. The Fidelity savings guidelines say a 40-year old should have a nest egg twice her annual income; by age 50, the egg should be four times income and at age 60, retirement savings should be six times current income.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.