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Retirement can be a daunting concept, especially if you have thoughts like “Will I ever be able to retire?” or “ I have no idea how much I need in retirement” floating around in your head.
Truth is, these are common concerns for many people who are considering their future retirements. Even if retirement is decades away.
How do you know how much you’ll need to have saved for your future retirement?
When will you be able to stop working? Will you be able to retire when you want to?
Figuring out how much you’ll need to have in retirement savings is a multi-step process. But once you have an idea of your savings need, it's easier to see if you’re on track.
What Will You Need to Retire?
Many personal finance writers recommend saving 25 times your expenses in investable assets, like stocks, that you can draw from in retirement.
The basis for this recommendation is the famous Trinity Study, published in 1998, whose authors used historical market data to determine the safe withdrawal rate for your portfolio in retirement.
They found, by backdating historical market data, that if you take out 4% of your portfolio in your first year of retirement, adjusting for inflation in subsequent years, the probability is very high that you will not run out of money during a 30-year retirement.
Since the study was published, 4% has been a number many financial advisors have used as a rule of thumb for pulling out of your retirement accounts.
Conversely, if you know how much you spend each year, multiplying those expenses by 25 gives you the dollar amount of the nest egg you’ll need to have saved to withdraw the same amount each year in retirement.
Some financial planners believe you would do better with a more conservative savings of 30 times your expenses.
While this might be true if you’re planning for a longer retirement (40 or 50 years or more), experts like Michael Kitces say that 4% is a good target, especially if you’re willing to adjust your spending as your portfolio rises and falls.
Determining Your Expenses
How much DO you spend per year, though? And will you need more or less during retirement?
Even if you’re not a fan of budgeting, these programs can help you get a handle on your yearly spending.
And not just your monthly bills, but also big annual or one-time bills like taxes, tuition payments, and home improvement projects.
They can also help you figure out what you actually need per year in retirement.
Suggested Reading: What Type of Budget Method is Best for Me?
There are some handy online tools to help you think through annual expenses.
These sites can help you think through costs you might forget, like Christmas gifts, annual premiums payments, or even magazine subscriptions.
If you can figure out your average yearly spending over the past five years, you’ll probably have a sense of how much you’ll need per year in retirement.
You don’t need to include your savings in your annual spending. Just calculate your spending on housing, transportation, taxes, healthcare, food, household expenses, insurance, travel, and your other spending categories.
Keep in mind your expenses may change in retirement.
For example, you may plan to have your mortgage paid off before you retire. If so, you won’t need to count mortgage payments in your monthly spending. Make sure that’s a realistic goal, though.
When you’re five years into a thirty-year mortgage and want to retire in seven more years, you’ll need to figure out how you’ll pay such a large lump sum off early.
You’ll probably have a different healthcare plan too.
Are you currently covered under your employers’ plan? If so, you will need to think about private health insurance and figure out the cost for you and your dependents in your state.
If you’re not planning to retire until you’re 65, then you’ll be covered under Medicare. Make sure to research how much supplemental insurance will cost with Medicare.
Some expenses may go down. You may cook more in retirement, so your Eating Out budget might be less. You may need to spend less on clothing when you’re not working.
Research has shown that spending in retirement generally follows a predictable pattern: at first, you tend to spend equal to what you did before retirement, and then, as you age, your spending decreases.
How Big Is My Current Nest Egg?
Once you have a handle on how much you’re spending and how much you might expect from Social Security (if anything), you’re ready to see if you’re on track to reach your goal.
There are many online calculators to help you figure out when you can retire, but you’ll need some information first.
Have you calculated your assets recently? If not, grab a notebook and set aside half an hour to do some tracking.
How much do you currently have saved and invested in the following areas?:
- 401k or 403b accounts
- IRAs – Traditional and Roths
- Taxable stocks
- Alternative investments
- Cash (Savings accounts)
Some people include the value of their homes into their nest egg. But as you’re calculating your retirement number, think hard about your home value.
- Are you planning to sell your home and move somewhere cheaper when you retire? If so, you may use some of your home equity in your calculations.
- Do you plan to continue to live where you are? If you do, you may want to exclude your home equity in your calculations.
The value of your current savings and investments will tell you how much you can currently pull out per month.
Is the value of your accounts $100,000? You can safely pull out $4,000 per year, or about $333 per month.
Do you have $500,000 saved and invested? You can pull out $20,000 per year, or $1,667 per month, from those accounts.
If the value of your current savings isn’t high, don’t give up!
In even a few years, you can save up a substantial amount of money, especially with the power of compound returns on your money.
For example, if you’re currently 45 and able to max out your 401(k) annually over the next ten years, you’ll have almost $250,000 in ten years with earning a modest 5% return on your savings over the next decade. (Note: This includes taking advantage of the ability to save $5,000 more per year with the Catch-up Contribution at age 50.)
What about Social Security?
Your number will change if you plan to include Social Security in your planning.
Take a look at your expected Social Security wages on this website to determine what you may receive each month in Social Security benefits.
Benefits are calculated based on how long you put money into the Social Security system and how much you earned.
You’ll receive significantly more in benefits if you defer benefits until you’re 70. But you decide when you start receiving benefits – as early as age 62.
According to the Center on Budget and Policy Priorities, the average Social Security benefit is $1514 per month, slightly less than $20,000 per year.
While this is a nice supplement, it’s not enough to cover all expenses during retirement for most people. The average amount spent per year by households 65 and older in 2018 was $50,860, according to the Bureau of Labor Statistics.
Also, consider the value of other expected income sources in retirement, like income from rental properties.
Do you expect to receive royalties, alimony, or an inheritance?
Do you plan to work part-time in retirement to supplement your income?
If any of the above applies, you can decrease your retirement number by a similar yearly amount to account for the additional income streams you expect to get.
As you age and your spending decreases, you may be less reliant on these other income streams.
Putting All the Pieces Together
So, let’s look at some hypothetical savers, Sue and Jane.
At the age of 42 and recently divorced, Sue’s currently spending around $38,000 per year. She hopes to spend a bit less in retirement as she’s in a low cost of living area and will be mortgage-free in 12 years.
Sue decides to use $40,000 in her projections though to be safe. Multiplying $40,000 by 25, she calculates she’ll need a cool $1M to fund her retirement years. Or does she?
Sue realizes she’ll get some Social Security benefits so she won’t need to save the whole $1M.
Using a conservative estimate of $20,000 per year in benefits, she now concludes her savings or other supplemental income will only need to cover the other $20,000.
She’d like a buffer for health care or other unanticipated expenses too. $550,000-$600,000 versus $1M sounds much more doable to her.
When Sue’s marriage ended she was left with the house and approximately $95,000 in savings. Since then she’s been able to save a bit more.
Now she believes she'll need to amass at least another $450,000 over the next 25 years to meet her retirement goals by the age of 67.
Using this simple calculator, Sue determines that if she can save at least $10,000 a year on top of her current savings, she could achieve $500,000+ in total savings with a modest rate of return at 5% and 2.5% inflation rate.
Once her mortgage is paid off in 12 years she’ll be able to save more annually. And if she can turn a hobby or two into sources of income she can add even more to her nest egg for additional peace of mind or earlier retirement.
Jane wants to know how much she and her partner will need to retire, and when they will be able to leave their full-time jobs.
First, she and her partner calculate their spending for the last five years.
Over those five years, they've spent an average of $62,000 per year for their family of five.
Eventually, three of their children will leave the nest, but $62,000 feels like a comfortable number for their annual spending.
They estimate $62,000 should be a number that can cover expenses and healthcare costs in retirement. Therefore, if they multiple that annual spending number by 25, they will need $1,550,000 in retirement savings to fund their goal.
While that seems like a lot of money to Jane and her partner, let’s look at their savings situation.
Currently, they have amassed $350,000 in their two work retirement accounts. Additionally, they have $50,000 in taxable accounts. They’ve been saving $15,000 per year in their retirement accounts ($7,500 each).
When they use a calculator like this one, they find that in 15 years, if continuing to save as they have before, their savings will be worth $1,155,250 with a 5% rate of return (a relatively conservative growth rate for stocks).
While that leaves them a little short of their goal, it will allow them to withdraw $46,210 per year.
With an expected Social Security benefit of $1,468 per month, or $17,616 per year, that's a total of $63,826 per year – more than they estimate they will need in retirement.
They could also take on part-time jobs in retirement to make up the difference and delay Social Security benefits for a few more years.
Alternatively, they could wait to retire in 20 years, continuing their yearly contributions, and their retirement savings would grow to $1,557,308, enough to fund their goals without needing to rely on Social Security.
Calculating Your Retirement Number
What are you waiting for?
Set aside an hour or so, figure out your yearly spending, tally your retirement savings, and plug your numbers into a calculator.
When will you be able to retire?
While calculating your retirement number might feel a little scary at first, knowing how much you need to retire, and having a clear plan to build your nest egg can mean retirement is closer than ever.
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