How Much Money Do I Really Need To Retire?
Unless you’re truly in love with what you do, you aren’t going to work forever. After giving decades of your life to the workforce, you’ll probably want to retire.
Finally, you’ll be able to wake up whenever you want, travel the world, move somewhere sunny, pursue your hobbies full time, get a nice car…
But hold on. Determining the amount of money you need to save to have a successful retirement is no walk in the park.
In fact, there are a ton of factors you need to consider when figuring out how much money you need to retire.
Expected Life Span
Retirement isn’t all fun and games. Part of planning your retirement savings involves determining how long you’ll think you’ll live after you retire.
This is one of the most important factors to nail down for a successful retirement as you don’t want to run out of money.
The best advice is to be optimistic; assume you’re going to pass away later rather than sooner. After all, it’s better to pass away with money leftover than to run out of money while still here.
Not only that, but nothing ever goes exactly according to plan. During your retirement, you may have some large, irregular expense occur. Being optimistic about your lifespan helps you create a financial buffer in the case of an emergency.
Of course, your money won’t vanish into thin air if you die early if you take the appropriate legal actions. Make sure you have your will and estate all in place to make sure the assets you leave behind go where you want them to.
Alright, so you’ve guessed how long you’ll live when you’re working years are behind you.
Now, you need to determine what kind of lifestyle you’ll want to live during that time period.
Do you want to settle into a humble, quiet existence once you’re free of the workforce? You probably won’t need as much money as someone who plans on traveling the world.
The most important thing to realize is you may not want the same lifestyle now as you’ll want in retirement.
Think about it: you’re about to gain a whole lot of freedom in the form of time, so your lifestyle choices could drastically change.
Maybe you were a frugal saver all your life and you want to blow it on fancy objects and/or experiences.
Or perhaps you’ve grown weary of pursuing material wealth and want to scale back to a simpler lifestyle.
Just make sure to decide on the lifestyle you want then without relying on your current lifestyle too much as a guide.
Many retirees enjoy the freedom at first, but soon grow bored with all their spare time. Some might even go back to work, albeit to part-time, fun work.
This is yet another lifestyle consideration to make. Having a job or even launching a business in retirement could even reduce your reliance on retirement savings, which is never a bad thing.
Cost Of Living
Similar to your desired retirement lifestyle, you need to figure out your minimum cost of living. If you haven’t already, start tracking your expenses so you know where every dollar is going.
And perhaps the biggest decision affecting your cost of living is where you plan to live out your retirement.
We aren’t sure many of these people exist, but some retirees like the sense of community and the selection of activities to do that comes from living in a big city. Their cost of living is going to be pretty high.
Compare that with slightly more common retired couple who wants to move to the middle of nowhere in flyover country. What would’ve bought them a nice apartment in NYC would get them a huge home and tons of land in Kansas.
Retirement age is important to consider for two reason:
- It affects how long your retirement will be
- It affects how long you have to save for retirement.
Most people retire in the 63-65 range and plan based on that.
However, some people get sick of the workforce and make plans to bail early. This is called FIRE or “Financial Independence, Retire Early” by some.
If you’re looking to get out of the corporate world early, you’ll have less time to save for a longer retirement. In other words, you need to be saving a significant portion of every paycheck and possibly scale back your lifestyle for a long time.
On the other hand, maybe you love your work and see yourself employed into your early 70’s. Theoretically, you won’t need to save as much of each paycheck since you’ll have more years to save and less years of retirement to pay for.
However, this is still risky. As you get older, health complications or other life events could cause you to retire before you were planning on doing so. At the very least, you should save as if you were going to retire at age 63-65.
Worst case scenario, you’ll be prepared. Best case scenario, you’ll have some extra cash to play around with in retirement.
When you’re young, healthcare is important but not a huge weight on your mind if you don’t rely on it for any medical conditions. You probably pay some negligible rate through your employer just to comply with the law anyways.
For obvious reasons, healthcare grows significantly in importance when you’re retiring.
First of all, you will no longer have that employer plan unless your spouse still works for a company that covers you. Thus, you’ll have to find a plan through some other government or private method.
In addition, you need a lot extra saved up for out-of-pocket expenses, as your aging body will require a few more doctor’s visits to keep everything running smoothly.
Oh, and we can’t neglect to mention: general healthcare costs seem to rise every year, so it’s safe to assume they’ll be much higher than they are now when you retire.
While you’re still employed, you should look into tax-advantaged medical spending accounts like HSAs. All contributions to HSAs are tax-free, and you aren’t taxed on your HSA spending as long as it’s used for qualified medical expenses.
Having a large HSA in retirement could mitigate a lot of worry when it comes to your healthcare plans, all while saving your tons of money in taxes over time.
Even in retirement, Uncle Sam can’t keep his hands out of your pockets.
If you’re a W2 employee your entire career, your income probably doesn’t go too far beyond your paycheck, making taxes relatively painless.
But in retirement, you’ll have multiple income sources that all have different tax rules.
An accountant and a financial advisor are great people to have on your team before and during retirement. They can help you navigate the complexities of investments/retirement accounts and find ways to optimize accounts for minimal taxation.
How Much To Save Based On Age For Retirement
Controlling for every other retirement factor and assuming you’ll retire in that 63-65 age range, your savings targets will vary based on your current age.
At age 30, you want to have saved at least 1 years’ worth of your current salary.
Once you reach age 40, you should be making a lot more money, so you’ll want around twice your current annual salary.
10 years after that, you should have 4 times your current annual salary saved.
At age 60, you’re approaching retirement. You’ll want about 6 times your annual salary.
Finally, when you retire anywhere between age 63-67, shoot for 8 times your current annual salary.
When we say current, we mean at that age. So at age 50, you’ll want to have saved 4 times the salary you make at age 50.
Again, these aren’t exact numbers you need to hit. They’re more of general guidelines; your needs may change based on retirement age and lifestyle.
Withdrawing The Right Amount In Retirement
Once you’ve figured out all your retirement considerations, you’ll need to add them together to get a comprehensive retirement budget.
Using this budget, you can then determine how much per year to withdraw so that you don’t run out of money.
There’s no 100% agreed-upon amount or even percentage you’re supposed to withdraw while you’re in retirement.
However, there are a lot of rules of thumb that provide a good start for determining that.
We’ll start with the most famous, the 4% rule.
The 4% Rule
One of personal finances most touted rules is the 4% rule of retirement. This rule states that you should save enough money to sustain a 4% withdrawal of the final amount every year for the entire duration of your retirement, with adjustments each year for inflation to maintain that 4% rate.
For the mathematically inclined and/or those who like to see what happens when you alter variables, here’s a basic formula (it doesn’t consider inflation) for better visualization: P = X/0.04, where P = your investment and X = amount per year.
There’s no variable for time, as this rule is conservative enough to assume you can live on 4% indefinitely. In addition, it’s assumed your assets will regrow enough to counteract some of your draw down.
Let’s say you expect to live on $40,000 per year. Solving for P, we discover you’ll need at least $1,000,000 in retirement.
Of course, that isn’t counting inflation. The best way to account for inflation aside from using inflation rates to make estimates is simply to save even more money.
The 25 Times Rule
The 25 Times Rule is based on the aforementioned retirement advice of withdrawing 4% of your retirement nest egg every year.
It assumes that you’ll live for about 25 years in retirement. In other words, it just assumes that “t” in our formula is 25.
First, you have to calculate your estimated retirement expenses. Then, you multiply that by 25 to get your total estimate retirement expenses.
Since you’ll withdraw 4% a year 25 times, you’ll have withdrawn 100% of your nest egg by the time you pass away.
Even with advanced medicine, 25 years is a long retirement period. Assuming you retire at 63, that means your estimating that you’ll live to be almost 90 years old!
Again, such optimism will provide you a financial buffer.
The 70 Percent Rule
The 70 Percent Rule is much simpler than the previous rule.
It says to assume you’ll need about 70% of your average income from your working years for each year of retirement.
For example, let’s say you average out your income over your entire career and come up with $60,000.
Using this rule, you’ll need about $42,000 per year for the rest of your retirement
This rule isn’t very accurate, but it’s a quick way to understand roughly how much money we’re talking when we talk about saving for retirement.
The 15 Percent Rule
The 15 Percent Rule is only effective if you’re young.
All it says is to save 15% of all your income for retirement, no exception.
If you haven’t started saving and you’re only 10 years from retirement, you won’t even be close to the amount of money you’d actually need by following this rule.
But if you put aside 15% of every paycheck from age 22 to 63, you’ll accumulate a large amount of “principal” that of course has time to earn returns.
There are endless investment vehicles you can park your money in, each with various benefits and drawbacks.
Most of people’s retirement assets sit either in specific retirement accounts or
Thus, most withdrawal methods involve living on bond interest income and the proceeds of stock sales. Even the famous 4% rule is based on this.
However, that means your nest egg will diminish every year since you’ll be selling shares or having your bonds move towards maturity (and therefore not grow in value), so there’s always that risk of running out.
To avoid this, many retirees boost their retirement income through investing in dividend-paying stocks and similar assets.
In fact, if you’re diligent, your dividend income can cover most of your retirement!
One reason for this is that you don’t have to reduce your principal investment. If you have $100,000 in a theoretical company that pays its investors 2% of their respective holdings in dividends annually, then you get $2,000 without having to sell of any shares.
But how do you build up a large enough dividend-paying portfolio?
Easy: through the power of compounding, which you can learn more about by clicking the link.
You first have to invest some money into dividend-paying assets as early as possible in your career, then reinvest every cent of dividends back into those same assets so your holdings increase.
Combine your ever-growing dividend-paying holdings with the fact that these dividend stocks can grow and you could build up a huge source of income overtime that doesn’t diminish with each payout.
Since the 4% rule errs on the side of frugality, making dividend-paying stocks part of your nest egg can give you a lot more financial freedom when you walk out of the office for the last time.
A Rule Of Thumb About Rules Of Thumb
All of these methods help simplify what your retirement will look like, but they don’t give you the most accurate picture due to your various sources of retirement income and the different tax considerations for each one.
In addition, your investments don’t suddenly exist in a vacuum upon retiring; they can still change in value.
For these reasons, you may want to work with a financial advisor to identify tax-efficient ways to withdraw your money, as well as forecast what the performance of your assets might look like come retirement.
As always, err on the side of saving more.
Retirement Ain’t Cheap
As you’ll notice, some of these factors play off each other. For example, where you live could affect the taxes you pay in retirement.
But before you consider any other factors in your retirement, consider your expected life span first.
Your expected life span kind of acts like a multiplier for many of the other factors you need to consider.
Here’s a very simple example: Let’s say you want to live on $50,000 per year.
Well, if your predicted life span is 10 years, you’ll need $500,000.
However, what if your predicted life span is 11 years? Obviously, you’ll now need $550,000.
So although the other factors are critical to determining how much money you need to retire, make sure you really nail down your expected life span.
As we said earlier, try to be optimistic with your estimate.
Aside from that, we’d like to reiterate that you should speak with a financial advisor when planning for retirement. They’ll make the whole process much easier, plus they’ll hold you accountable so you don’t stray from saving.
But if you take nothing else away from this article, just remember these words:
Retirement isn’t cheap. The best time to start saving was yesterday; the next best time to start saving is now!