Getting your 'number' right

IF YOU RESOLVED to save more for your retirement in 2014, you may be happy to hear about some new research on estimating the income you'll need.

To have enough money for when you are no longer working, you have to know your "number." That is a calculation based on various factors such as the rate of inflation, how much you are expecting from Social Security, an estimate of how much your investments might earn and how long you think you might live. The calculation also estimates the percentage of pre-retirement income you'll need to replace. That percentage is called your "replacement rate."

It used to be that retirees would estimate they could make do on about 40 to 50 percent of what they used to earn a year because they wouldn't have the same costs they did while working. Their children are grown and on their own. They probably wouldn't have a mortgage or all the expenses associated with working, such as commuting costs.

But many of today's retirees want to live life more abundantly. Their children and grandchildren may not be close by, so they need to budget to travel to see them. And many won't pay off their mortgages before they retire. So retirement calculations may suggest they need to replace about 70 to 80 percent of their yearly pre-retirement income because their expenses won't greatly be reduced in retirement.

Still, the higher assumptions so common now might be too much, leading people to overestimate how much they will need to fund their retirement, according to David Blanchett, head of retirement research for Morningstar Investment Management.

"While a replacement rate between 70 percent and 80 percent may be a reasonable starting place for many households, when we modeled actual spending patterns over a couple's life expectancy, rather than a fixed 30-year period, the data show that many retirees may need approximately 20 percent less in savings than the common assumptions would indicate," Blanchett writes in a research paper.

Some people may find that their actual replacement rate is likely to be below 54 percent, he notes. Part of the reason people may need less is that their consumption tends to decline as they settle into retirement. Many other expenses also go away, such as Medicare and Social Security taxes.

But before you breathe a sigh of relief, understand that how much you need is contingent on so many factors. For example, if a high-income couple who saved a lot while they lived in a high-income-tax state such as California move to Florida or Texas, where there is no income tax, their retirement replacement rate might be closer to 60 percent.

However, if a low-income couple who haven't saved much retire in a high-cost area, they might need a higher replacement rate.

"Although a 'rule of thumb' replacement rate of 70 percent to 80 percent is clearly reasonable, it isn't ideal and, moreover, it is clear that the replacement rate is sensitive to the proportion of pre-tax expenses to post-tax expenses," Blanchett writes.

When people ask me how much they need to save for retirement, or what percentage of their income should they be saving every paycheck, my standard response is: "It depends."

It depends because you have to guess about so many things. It depends because you might become very ill and, although you've saved a lot, you might not have enough to cover expenses.

It wouldn't be prudent to latch onto a certain arbitrary percentage and think you've got your number. It has to be personal to you. You've got to do the calculations making the best informed estimates you can.

From what I've seen personally and the studies I've read, most people aren't saving nearly enough to retire. So keep that resolution to save more for retirement on your list. Better to err on the side of too much rather than too little.