A question that lurks in everyone’s mind is, “How much money do I need to retire?” While it’s a simple question, the answer is anything but that. Unfortunately, there is no magic number or one-size-fits-all solution. Everyone’s number will vary due to a multitude of factors. So, while one person might need $2 million to retire, another may only require $750,000.
Working with a financial advisor is generally the best way to ensure you don’t outlive your money in retirement. But several methodologies can help you determine a ballpark figure to assist with planning.
The following guide will reveal ways to estimate your retirement number and identify crucial factors often overlooked by future retirees.
Retirement Rules of Thumb
There are a variety of methods when it comes to estimating your retirement number. Each has its own set of flaws, but they’re good starting points if you’re looking for a general range. Here are basic overviews of four common rules of thumb:
- $1 Million: Who doesn’t want to be a millionaire? Some people choose a big, round number to shoot for as their retirement target. But $1 million doesn’t go as far as many would hope – especially when it has to support you (and your spouse) for potentially 30 or more years.
- 10 – 12x Pre-Retirement Salary: This methodology uses your current income to estimate your retirement needs. To obtain your number, you will multiply your current pre-retirement salary by either 10 or 12.
For example, assume your salary is $100,000 prior to retirement. Your retirement number would be between $1 million – $1.2 million.
- 80% – 90% of Pre-Retirement Income: This rule takes a different approach and helps you to estimate how much money you’ll need annually in retirement.
For example, if your pre-retirement income is $100,000, you need a retirement plan that distributes between $80,000 – $90,000 annually.
- The 4% Rule: One of the most famous and highly debated methods is the 4% rule. Essentially, this rule of thumb states that you can withdraw 4% of your saved investments in the first year of retirement. Then, you’ll adjust your withdrawals for inflation in the following years.
It’s a popular rule because it can work effectively. However, it also has several flaws. For example, it assumes your portfolio will be made up of 50% stocks / 50% bonds.
Here’s an example to illustrate how the 4% rule functions. Imagine you retire with $1 million in savings. The first year, you could withdraw $40,000. If inflation increases by 3% next year, you will withdraw 4% plus 3% of that amount for inflation ($40,000 + $1,200 = $41,200).
BONUS: You can also use the 4% rule in conjunction with other methods. For example, assume you determine you need $80,000 annually in retirement (from the 80% – 90% of Pre-Retirement Income method). Since that figure is 4% of your total retirement number, you can multiply the $80,000 by 25 to determine how much you will need to save.
For example: $80,000 x 25 = $2,000,000 | $2,000,000 x 4% = $80,000 / year
Overcoming Sticker Shock
When you begin plugging in numbers, the high-dollar amounts can make anyone’s heart start racing. These aren’t small figures, and the thought of saving that much money can make people panic.
But before you start watching reruns of “Extreme Cheapskates” and searching the couch cushions for change, know these figures can be misleading. They rarely paint the whole picture, and your retirement number might be significantly less.
Here are two crucial items to consider:
- Social Security: The figures above don’t factor in retirement benefits, such as Social Security or any pensions you may receive.
- Eliminated Costs: Many expenses you’re accustomed to may no longer exist upon retiring. For example:
- If your home is paid off, you’ll no longer be paying a monthly mortgage.
- You’ll eliminate work-related costs like commuting, work clothes, etc.
- If you previously paid for health insurance, you may now qualify for Medicare.
- If you’re driving less, you might only need one vehicle – and you may qualify for discounts on your car insurance.
- You’ll no longer be putting money into your retirement accounts.
- If your children are grown, you’ll no longer be contributing to their college funds.
With the absence of these costs, your retirement number could decrease significantly.
How Much Do You Need to Retire?
To build off the example from earlier (and to provide peace of mind), the following will illustrate the significant role Social Security plays in your retirement plan.
Earlier, you determined you need to receive $80,000 annually to live comfortably in retirement.
Now, assume you and your spouse each receive $1,750 in monthly Social Security benefits.
$1,750 x 2 = $3,500 per month | $3,500 x 12 = $42,000 annually
If you earn $42,000 in Social Security benefits each year, you will need a retirement plan that will give you $38,000 each year.
$80,000 (Annual Retirement Goal) – $42,000 (Social Security Benefits) = $38,000
Using the 4% Rule, you can multiply $38,000 x 25 to determine your retirement number.
$38,000 x 25 = $950,000 (Your Estimated Retirement Number)
You can see that $950,000 is significantly less than the $2 million originally estimated. And this figure still doesn’t include any pensions you may receive or other items like future inheritances. It’s important to note that this estimate also does not include taxes, which will definitely come into play.
Understanding the Value of a Financial Advisor
Between retirement rules of thumb and online calculators, you’ll be able to estimate your retirement number. But nothing will compare with the service a financial advisor can bring. They’ll be able to plug in your information and generate outcomes based on a multitude of scenarios.
Many variables that will come into play include:
- Your age at retirement.
- When you decide to take Social Security.
- Your future retirement lifestyle.
- Your current health & future healthcare costs.
- Whether you plan to downsize your home or use a reverse mortgage.
- The impacts of inflation or market swings.
- Tax rates at the time of your retirement.
We’re Here to Help!
Retirement planning can often feel overwhelming. Too often, people compare themselves to others and become discouraged. But there is no one-size-fits-all solution, so seeking guidance is essential.
If you’re interested in learning more about retirement planning or want a second opinion on your existing plan, we’re here to help. Please contact our Wealth Management Team.