You know you need to save for the future, but beyond that, the details might seem fuzzy: For example, how much does one need in retirement savings? What should one plan for in retirement income each year? And perhaps most importantly, how long will retirement savings last?

“A lot of people think retirement is Mai Tais on the beach, that it’s a vacation,” Lopez says. “But realistically, it isn't. What the retirement goal looks like is subjective and looks different for everyone,” says Eddie Lopez, a retirement expert at Titan. “But the tools for everyone are essentially the same.”

To determine their individual retirement goal, investors take into account their current standard of living, how they want retirement to look, when they expect to retire, and a few other details. There are also a few ways to maximize retirement savings, including something called the 4% rule, investing the money rather than just hanging onto cash, and—perhaps most importantly—starting early.

Budgeting for retirement

Even for those who do have a beachfront fantasy for retirement, one key strategy for stretching retirement savings is being frugal. “In order to help retirement savings last, minimize living expenses as much as possible,” says Lopez.

To begin planning for the future, start by considering current spending. A retirement budget is typically informed by one’s pre-retirement standard of living, based on pre-retirement income.  

Speaking generally, experts say most people need about 80% of that pre-retirement income once they retire. For illustrative purposes, if an investor is making $100,000 a year while working, they’ll need about $80,000 a year once they retire. Experts say those who live above or below their means will need to adjust that percentage, but it’s one place to start.

How does that annual retirement income break down? First, investors budget for the non-negotiables: the essential items like housing and food that they know they’ll absolutely have to continue paying for in retirement. While these costs can vary widely across the country based on where they live, federal data from the Bureau of Labor Statistics about what the average retirement-age American spends can provide a guideline. Again, investors consider their own personal pre-retirement standard of living when adjusting these averages.

• Housing.

  Mortgages and rentals may be one of the most variable costs based on geographic area, but as of mid-2020, the BLS said Americans 65 and older spent an average $17,151 annually on housing. That nets out to almost $1,430 a month, representing the lion’s share of spending at 35.7%.

• Health care.

  Coming in at a distant second—but still a significant outlay at 14% of spending—health-care costs averaged $6,719 a year or$560 a month, according to BLS.

• Transportation.

  Those in urban areas may spend most or all of this budget component on public transportation, while residents of suburban or rural areas are more likely to have one or more cars. BLS found the average amount that people 65 and older spent is $6,618 each year or just over $550 a month, which comprises 13.8% of total spending.

• Food.

  Another highly variable category based on eating and cooking habits, as well as access to nearby grocery stores and restaurants, food costs averaged 13.1% of total spend for retirement-age Americans. That’s equivalent to an average of $6,303 a year or about$525 a month.
  

Average annual spending on those four essential categories totals just under $36,800 a year. Investors adjust those based on their lifestyle and expectations and consider how much they want to reserve for non-essentials like travel and entertainment, as well as potential unexpected costs like major home or auto repairs.

How the 4% rule can help savings last longer

Once investors have a sense of their need for annual retirement income, they determine how long they expect their retirement timeline to be. People are living longer on average, and some opt to retire early at age 62 or even sooner. Others opt to delay retirement so they can receive additional Social Security benefits.

No matter what they decide, they want to be confident that their money will last in retirement and that they aren’t taking out so much each year that they outlive their savings. That’s where the 4% rule comes in. Some experts say that if an investor withdraws 4% of their savings in the first year of retirement, and then in the following years add a bit on top of that to adjust for inflation, they have a high probability of maintaining enough savings for a 30-year retirement.

For an example using easy math, say an investor’s total retirement investment savings is $1 million. They would withdraw 4%, or $40,000, in their first year of retirement. That becomes their baseline “income” for the following year: If the rate of inflation is 2% the following year, they would add 2% of their $40,000 baseline, or $800. So they would withdraw $40,800. The following year, they would use $40,800 as their new baseline when calculating what they’ll add for inflation.

This is another generalized rule of thumb—some say the 4% rule is too conservative, while others say that withdrawal amount is too much. But it’s a starting point for considering what can be safely withdrawn each year, as well as how long retirement savings will last with inflation.

The importance of investing for retirement

Those 4% rule guidelines are based on investment income. It doesn’t take into account other potential sources of cash like Social Security, a pension, or side gigs.

People invest for retirement because none of these other streams of income are designed to support their retirement. The Social Security Administration warns that Social Security “should be just one part of your retirement plan,” noting most beneficiaries receive only 40% of their pre-retirement income through these funds.

Tax-advantaged investing

What’s more, investing for retirement offers tax advantages. Two types of accounts were created to encourage investors to save for retirement: Tax-deferred accounts like 401(k)s allow investors to put pretax money in when they contribute and pay taxes later, while tax-exempt accounts such as a Roth IRA use after-tax funds but later let investors withdrawthe money tax-free.

Through employer-sponsored retirement plans like 401(k)s—or 403(b)s if you work at a nonprofit or tax-exempt institution like a school or a charity—some companies match part of employees’ contributions. That’s effectively free money. (Other investors may opt to put money into an annuity they can draw income from in retirement.)

Those who don’t receive an employer match can still use investing for retirement to maximize their savings. It’s called compound interest, and it refers to the reason it pays, literally, to invest in retirement early: Investors effectively earn interest on interest. This effect compounds over time, and it can help savings increase exponentially as the years go by.

The bottom line

Saving early for retirement is important for many investors, because sources like Social Security usually aren’t close to enough. Investors can consider their current standard of living and note that experts say most people need 80% of that pre-retirement income. To decide if they’re saving enough, some experts recommend investing with the 4% rule in mind: If they withdraw 4% of retirement funds in the first year and then adjust for inflation in following years, they say, they have a high probability of not outliving their money. Investing savings for retirement can provide tax advantages and compound interest.