How much money do I need to retire?

I was recently asked by a friend if I’ve calculated the amount of money I need for retirement, and if so, how did I do it?  I think he was surprised by my response that I calculated the amount a long time ago when I first started working and have been updating the plan numbers every year based on new information. I asked him if he had a retirement plan and his response was that he’s also been saving for retirement since he started working many years ago, but his “plan” was to save as much as he could, whenever possible. 

This raises an important distinction:  Saving for retirement is not the same as planning for retirement.  At some point you may have learned that if you save 10% of your earnings each year then you’ll have a nice “nest egg” for retirement.  While that may be enough, it may not be enough.  A plan answers the questions:

  1. At what age do I want to, or can I, retire?
  2. How will I get there, considering other short and medium-term goals?
  3. What happens if my goals and plans change?

Answering these questions raises another important point:  Even having a plan is not enough.  You must be prepared to update that plan based on more current events, such as changes in investment returns or unforeseen expenses.  As referenced in my last article on financial literacy, people that plan for retirement have double the wealth of people that don’t plan for retirement.  In this article I’m going to cover a couple of resources that will help you quickly determine how much you need depending on whether you are a long way from retirement or nearing it.  Keeping these numbers fresh is up to you.

I’m a long way from retirement

Even if you’re a long way from retirement it is important for you to do some math to figure this out, since it is more than likely the biggest investment you will make in your lifetime.  Figuring it out early also allows you to compound money, a key catalyst for growing savings.  To build a more realistic plan, you will need to answer the questions above and estimate the ‘cost’ of achieving short, medium, and long range goals; and then be prepared to adjust based on new information.  However, if you simply want to estimate how much you need as a starting point to your plan, I suggest using this calculator.  As an illustration (see exhibit 1 below), a 25-year old who wants to retire at 60 with $0 saved today would need to save 15% of their income on average per year to have enough saved to live ~30 years after retirement.  This doesn’t include social security benefits, but I believe those should be left out of early plans.  Social security benefits can be factored into your plan  when you’re closer to retirement, and can estimate those benefits better.  Also, do not assume any inheritance in your plan.

I’m nearing retirement

If you are nearing retirement, figuring this out is an imperative so that you don’t outlive your money.

Start by projecting your expenses and income during your retirement years.  To project these numbers, you need to know your current expenses and what changes will occur when you retire.  There are a few ‘rules of thumb’ you could use, but I recommend that you go through each expense category and estimate any impacts based on retirement plans.  For example, are you planning to downsize or move to state with a lower cost of living?  It’s not only important to figure this out for financial purposes, but it will also spur you to get on same page with your significant other, as needed.

Let’s say you calculate your projected annual expenses and estimate you’ll need $65,000/year to live on.  To figure out how much money you’ll need in total, take amount needed annually and divide by distribution rate.  Most planners start with 4% per year, so assuming you need $65,000 a year to live on, it would be $65,000/4% = $1,625,000.  That amount will last you 25 years.  If you want it to last longer then you need to withdraw less each year.  For example if you withdrew $55,000 per year, you could make that amount saved last nearly 30 years.  This relatively simple calculation leaves out social security and other income.  To find out how much money you will get from social security visit the Social Security Administration website and sign in/up to your account to see your current/projected benefits.

Another very important consideration during retirement years is health care costs. According to Fidelity Investments, a 65-year old couple retiring this year will need $275,000 (in 2017 dollars) to cover medical expenses throughout retirement, assuming traditional Medicare coverage but not potential costs associated with nursing home care.  If you live 30 years post-retirement and assume you’ll need $300,000 to cover healthcare, that works out to an additional $10,000 per year on average in expenses you need to account for.

Now that you have a fair estimation of your expenses and income, plug it into this calculator (exhibit 2) to see how long you’re your money will last.

Another big question that often arises during retirement is when to take social security.  This useful article from The Motley Fool can help you figure out the break-even point for claiming social security at different ages.

So, in summary:  Create plan. Adjust plan. Retire confidently.

I hope you found this article useful. If you would like to thank me, please help me raise money for my financial literacy education scholarship by purchasing my digital products.  Click here to find out more.

Leave a reply