One of the biggest retirement planning questions is how you can continue to pay for the things you need after you stop working. So, the question becomes how much money you need to retire comfortably. There’s no single answer for all retirees, but you can figure out how much you’ll need with the steps below.
Some people can retire with a few hundred thousand dollars, while others need more than $1 million (sometimes substantially more). The amount you need depends on:
- How much you need to spend each year or month
- The amount of income you receive from Social Security or pensions
- How much you earn or lose on your savings
- Inflation (rising prices over time)
- Your retirement age
- How long you live
- Whether you are married, single, or something else
Understanding these factors is one of the most important things you can do for your retirement. But you might just want to start with a rough number, and you can use several strategies to estimate how much you need:
- Income replacement goal: Aiming for 75% or higher is best.
- Multiply by your salary: For some people, roughly 10 times your salary at age 65 might be appropriate.
- Multiply by 25: Start with the amount you want to withdraw from savings each year, and multiply that by 25.
- Detailed financial plan: Run the numbers with customized assumptions.
We’ll cover each of those strategies below.
Your Spending Level is Crucial
The first step of retirement planning is to identify your goal. With a spending range in mind, you can determine if you’re on-track or if you need to make significant changes. Start by estimating how much you need to spend each year or month.
Why does this matter? The more you need to spend each month, the more money you need for retirement. If you can keep your spending relatively low, reaching a retirement goal is easier.
There are several ways to estimate your need:
- Income replacement ratio: You can start with the amount you earn today and set your retirement goal to be a percentage of your current income. For example, if you earn $100,000 per year at your job, and you want to replace 80% of your income, the goal is $80,000. The correct ratio is different for everybody, but it’s best to stay at 70% or higher—the higher, the better.
- Spending plan: Also known as a budget, you can create a retirement spending plan. You might use many of the same expenses you have today, such as housing and food costs. But you may eventually pay off your mortgage and travel more, so you adjust those categories. This approach allows for the most detail, but it’s labor-intensive, and you’re predicting the future (which nobody can do with 100% accuracy).
Healthcare spending: Remember that things change in your retirement years. Healthcare expenses will likely increase since your employer is no longer funding health insurance premiums. Fortunately, you may be eligible for Medicare at age 65, which you’ve been paying for with payroll taxes during your working years.
Rising prices: Over time, prices tend to increase due to inflation. As you calculate the amount you need in retirement savings, be sure to include an inflation factor. Inflation has been relatively low for the last 20 years, staying below 3% per year (with a few exceptions). Still, even low inflation can eat away at your savings and your purchasing power.
Savings Checkpoints Based on Salary
Some financial institutions suggest multiplying your current salary by different numbers to calculate the amount you need. At age 65, that number is often around 9% to 10%, but it might be higher or lower, depending on how much you earn. With higher earnings, Social Security replaces less of your pre-retirement income, so you use a higher multiplier.
Multiply by salary example: Assuming age 65 and an income of $80,000, multiply the “checkpoint” of 9.1 by your income. $80,000 times 9.1 is $728,000. That’s how much JP Morgan says you should have if you want to retire at age 65 (if the assumptions are accurate).
Add Up Your Retirement Income
For a better understanding of how things will unfold, add up any income you expect to receive in retirement. This income is a “base” of monthly income that lasts for the rest of your life. For most people, that includes Social Security and pensions.
Social Security: The average Social Security retirement payment is $1,514 per month, resulting in about $18,000 per year of income. You might get more or less, depending on your work history.
Pensions: A pension can also provide lifetime income, although pensions are increasingly rare. If you qualify for a pension, include that in your base retirement income. But if you worked for a government employer that did not contribute to Social Security, be sure to check if the pension will reduce (or eliminate) your Social Security benefits.
Annuities: If you get retirement income from an annuity (assuming a reliable insurance company), you might or might not include that income here. The guarantees on annuities are not quite as robust as what you get from Social Security or a pension. That said, it’s reasonable to expect that the strongest companies are likely to pay benefits.
Now you know the amount you need and the amount you earn:
Example: You receive $20,000 per year of Social Security income, and you get a pension of $6,000 per year. You want an income of $50,000 per year.
- Your base of income is $20,000 plus $6,000 = $26,000
- The “gap” you need to fill is $50,000 minus $26,000 = $24,000
- As described below, you can fill the gap with withdrawals from your retirement savings
Manage Earnings or Losses on Savings
The amount you earn or lose on your retirement savings affects how much you need to retire. You face a challenging balance between pursuing growth and avoiding losses:
- If you take risks and attempt to grow your money aggressively, you could lose money. Taking withdrawals during market crashes can deplete your portfolio, and you risk running out of money early.
- If you avoid risk altogether and keep your money in government-guaranteed bank accounts, you will need to save significantly more for retirement. As a result, you might have to wait substantially longer to retire. Plus, you might struggle to keep up with inflation, and you may run out of money if your retirement savings don’t grow.
Ultimately, you need to find a balance between growth and safety. That may mean investing a portion of your money with a goal of growth (in the stock markets, for example) and investing a portion in safer investments (like bonds, which can potentially lose money, and cash-like investments).
For context, the 4% rule for retirement, which we’ll describe below, initially used an investment mix of 50% in stocks and 50% in bonds. The study assumed annual rebalancing to keep the portfolio more or less at that 50/50 level. That approach might or might not be right for you, but it’s what we might call a balanced investing strategy.
How Long Will You Take Withdrawals?
The length of your retirement in years determines how much money you need to retire. The longer you plan to take withdrawals, the more money you need. Your retirement’s timespan depends on two things:
- How old you are when you retire
- How long you live
For a couple, it’s slightly more complicated, but you’d look at how long the last survivor lives.
Your retirement age matters: When you want to retire early—in your 50s, for example—you need more money saved for retirement. You can get by with less money if you retire at 60 or 70. That’s because early retirement results in needing to fund more years (or months) of income. You won’t die any earlier when you retire early, presumably, so you’re just extending your withdrawal period.
Most people plan for roughly 30 years of retirement. When retiring at age 65, that provides funding until your mid-90s, which should cover most of today’s retirees. If longevity is in your family, you should be more conservative. One rule of thumb, the 4% rule, tells us a lot about 30-year retirement timeframes.
4% rule: The 4% rule assumes that:
- You withdraw 4% of your assets at retirement each year
- Your withdrawal amount increases each year with inflation
- You invest approximately 50% in stocks and 50% in bonds
- Your money ideally lasts 30 years
This rule of thumb looked at some of the worst periods in history, such as a retiree who started taking withdrawals just before a difficult economic cycle. The goal was to figure out what rate was “safe,” although we can’t guarantee that 4% or any other rate will be safe during future periods. That said, given the worst-case scenarios available at the time, the 4% rule held up in Bill Bengen’s testing. If you want to be safe, feel free to use a lower number, such as 3%, 3.5%, or less.
Calculating your retirement need: You can reverse the 4% rule to determine how much money you need to retire. To do so, multiply your monthly spending need by 25. The result is a starting balance that would likely provide inflation-adjusted income for 30 years or more.
Multiply by 25 Example: Assume you need withdrawals of $2,000 per month to supplement your Social Security income:
- Multiply $2,000 by 12 months to arrive at an annual need of $24,000
- Multiply $24,000 by 25 to find $600,000 (this is how much money you need at your retirement date)
- Check your math with the 4% rule: Multiply $600,000 by 4% (or 0.04) to find out how much you can spend each year
- The result is $24,000
You can also try a few quick calculations for rough estimates (please get more specific numbers with a detailed financial plan).
How to Minimize The Amount You Need
If you’re finding that you need substantially more to retire than you believe is feasible, there are several potential solutions. None of these will be enjoyable, but they may provide a realistic path to retirement.
Retire later: This is a powerful strategy to reduce your savings need.
- Minimize the number of years’ worth of withdrawals needed.
- Potentially earn more from Social Security due to a higher age and more earnings history.
- Save more for retirement during those extra working years.
Spend less: This obviously has limits—you can only cut costs so much. But reducing your spending goal makes a smaller nest egg last longer.
Your Own Calculations
This page is a simplified example of how you can plan your retirement income. As you might imagine, real life is far more complicated, but this may help you begin the process. It’s best to account for unknowns in life, such as years when you might face unusually high medical expenses. Plus, we’ve ignored taxes (among other things) in this example, so you need to include more items for a thorough analysis. Remember that there are no guarantees in life—you can potentially lose money or run out of money early. Do more research or work with a skilled financial advisor if you have any questions. If your advisor is not helping you with this, get a new advisor or contact me to learn more about working together.