This post contains an excerpt from Chapter 13 of Your Money: The Missing Manual, my new book from O’Reilly Media. It’s also a part of National Financial Literacy Month.

For the past several months, GRS has been running a new poll in the sidebar every two weeks. Mostly, these are curiosities to me. But the poll that just concluded produced an interesting tidbit of information.

The most recent poll — which ran simultaneously at Money Rates — simply asked: If you were 65 and retiring today, how much do you think you would need? For most polls, the responses at GRS and the responses at Money Rates are very similar. Not this one. Take a look at the final tabulation:

  GRS MR Total
under $500k 8% 10% 9%
$500k – $999k 22% 36% 24%
$1mil – $2mil 42% 36% 41%
over $2mil 27% 18% 26%

According to this (very unscientific) poll, the youngish people who hang around this site are much more pessimistic about the future than the older folks who hang around Money Rates. Only 30% of you think that, if you were 65, you could retire today with less than a million dollars; 69% think you’d need more than that. But 46% of the older crowd at Money Rates thinks that less than a million would be enough.

So, who’s right? Could a 65-year-old retire today with less than a million bucks? Or would she need much, much more?

Figuring out how much to save
Because you can’t see the future, there’s no way to know exactly how much you’ll need to save for retirement. All you can do is make your best guess, taking these variables into account:

  • When will you retire?
  • How long will you live? (You can get an estimate at Living to 100.)
  • How much will you spend?
  • What will your health be like?
  • How much will you save and how aggressively will you invest?
  • What will the inflation rate be between now and the time you retire?

Because there’s so much uncertainty, financial planners use Monte Carlo simulations, which analyze tons of historical data to estimate, based on your current savings and planned retirement date, how likely you are to run out of money in retirement. The results can help you plan how much money to save.

Monte Carlo simulations are great but complicated; you’ll probably need to consult a financial planner if you want one run for you. But you can get started by making some rough estimates by hand — and with the help of web-based retirement calculators.

Tip: Delaying retirement can only help your financial situation. The longer you work, contribute to your retirement savings, and go without tapping Social Security and retirement accounts, the more money you’ll have later.

The Traditional Method
Most retirement calculators — both on the Web and from financial planners — estimate how much you’ll need by using your income as a starting point. They’ll suggest you need 70% (or 80% or 100%) of your pre-retirement income to maintain your lifestyle. But does basing this estimate on your pre-retirement income really make sense?

  • Say you make $50,000 a year but spend $60,000. In that case, your income understates your lifestyle by $10,000 a year. If you based your retirement needs on your income, they wouldn’t come close to supporting your lifestyle.
  • On the other hand, if you make $50,000 a year but only spend $25,000, basing your retirement needs on your income would lead you to save much more than you need.

As you can see, estimating how much you’ll need in retirement by looking at your current income doesn’t make much sense. It’s one of those rules of thumb — like “buy as much house as you can afford” — that can actually do more harm than good. There’s a real danger that by following this advice, you won’t have enough saved for retirement. But just as bad, there’s a chance you’ll have saved too much, meaning you missed out on using money to enjoy life when you were younger.

Instead of estimating your retirement needs based on your income, it makes more sense to base them on spending. Your spending reflects your lifestyle; your income doesn’t.

Tip: You can get a quick estimate of the Social Security benefits you’ll receive — if that program is still around when you retire — using this Quick Calculator. For a much more accurate estimate of your future benefits, check the Social Security Statement you receive in the mail every year.

A Better Way
If you’re going to base your savings goals on how much you’ll spend in retirement, you’ve got to have a way to gauge your future spending. Will your expenses increase or decrease? That depends in large part on your health and your plans. If you get sick or travel a lot in retirement, for example, your expenses may go up. In general, though, your expenses will likely stay about the same. According to the Employee Benefit Research Institute’s 2009 Retirement Confidence Survey:

  • 49% of retirees spend less in retirement than before (26% spend much less)
  • 35% spend about the same as before retirement
  • 14% spend more in retirement (though 7% say their expenses are only “a little higher”)

Overall, 65% of Americans spend about the same or only slightly more or less in retirement. That means their pre-retirement expenses are a good predictor of their post-retirement expenses.

Note: You can download the full EBRI report for free. It’s filled with tons of data about Americans’ attitudes toward retirement — and the realities of being retired.

Expenses often drop in retirement because your kids are out of the house; your mortgage is gone—or nearly so (one of the surest steps toward retirement security is to pay off your mortgage); you have no commuting costs or other work-related expenses; and, ironically enough, you no longer have to save for retirement. Sure, you’ll have other expenses — especially health care — but if you’ve been smart and planned ahead, you should be in good shape.

Make no mistake: You will need a sizable nest egg for retirement — especially if you have ambitions to travel or want to golf every day. In fact, you should save as much as you can. But don’t be snookered by the constant refrain that you need 70% of your pre-retirement income. That’s nonsense—base your savings goals on your projected expenses instead.

The moral here? Don’t panic — you can save enough for retirement. In Retire Well on Less Than You Think, Fred Brock writes:

Most people can retire from wage slavery sooner than they think if they are willing to pay a relatively painless price for their freedom: a simpler, downsized life and, perhaps, a move to a less expensive part of the country — and it doesn’t have to be remote or far away.

The key is to live within your means now, which lets you boost your cash flow so you can accumulate savings for later in life.

Retirement Calculators
Enough theory! You’re probably ready for some hard numbers. In that case, you can get a quick estimate of how much you’ll need to save by heading online. There are hundreds of retirement calculators scattered across the Web, and each one is a little different. Because this is all a guessing game, no one calculator is necessarily better than any other, but here are a few I’ve found especially insightful:

For a great combination of simplicity and complexity, check out FireCalc.com. This site may seem overwhelming at first (there’s a lot of text to read), but it’s actually fairly elegant. What it does is give you an idea of just how safe or risky your retirement plan is based on how it would have withstood every market condition we’ve ever faced since 1871. All you do is enter how much you’ve saved, how much you think you’ll spend every year, and how many years you expect to live in retirement. Then FireCalc spits out a percentage telling you how likely your retirement plan is to succeed: 0% means that it never would have worked in the past, and 100% means it always would have succeeded.

Note: In How to Retire Early and Live Well, Gillette Edmunds shares his formula for calculating retirement needs based on current expenses. His formula takes taxes, inflation, and investment returns into account. It’s too math-y for our purposes, but if you’d like to calculate things by hand, track down a copy at your local library or used book store.

Looking at the results from just one calculator isn’t very useful, but if you compare the numbers and recommendations from several, you can get a pretty good idea of how much you’ll need to save for the retirement you want. If your results are anything like mine, you may feel a little overwhelmed. In that case, make a commitment to start saving for retirement today.

Tip: Analyzenow.com has lots of great info about sensible retirement planning. The site doesn’t include a calculator, but it offers plenty of free downloadable, spreadsheet templates so you can run your own numbers, as well as tons of articles about retirement planning.