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How Much Money Do You Need to Retire?


It is the single most important question on most people’s minds; yet, because there are so many variables, it is one of the most difficult to answer. Considering that saving for retirement is still a relatively new concept, even us financial planners are still trying to figure things out. For much of the last century, most people simply worked until they died. This century has seen the demise of guaranteed pension plans, which has shifted the burden of saving on the shoulders of individuals. So, the question has to be asked and, realizing that there are many variables that come into play, you need to have an appropriate target to shoot for.


It Starts with Your Spending Needs

There are a number of different formulas used to determine how much you will need to live comfortably in retirement; but they are all premised on one key factor – your retirement expenses. Knowing how much money you will need to save for retirement is easier to determine when you know how much you will spend in retirement. If your time horizon is still a ways off, it might be more difficult to estimate your expenses; but, if you are within 10 years, it can be a more realistic exercise. In either case, having a clear vision of what you want your retirement to look like will make it easier to estimate what it will cost.

The exercise involves creating a monthly budget around your expected retirement lifestyle. Of course, it needs to account for any changes you expect to make in your lifestyle between now and then. For example, will you be downsizing your home or moving to a less expensive area? Will you be carrying any debt into retirement? Will you have any dependents relying on your financial support? How will your spending change between now and retirement? The idea is to create your retirement budget now based on your vision for retirement and make adjustments to it as your circumstances or goals change.

Many financial planners suggest using the 70 percent rule to form a baseline for your budget. The rule says that, on average, retirees can expect to replace 70 to 80 percent of their income in retirement. It assumes that some expenses will decrease, such as work-related and housing costs. But, don’t assume you will spend less money across the board. Other expenses may increase, such as travel and leisure. To plan more conservatively, you can start with a higher baseline of 80 to 90 percent. Your budget number, the amount you expect to spend each month, becomes your actual target because you will need to accumulate the amount of capital to be able to hit it every month for the next 30 years or more.

Next, you can subtract the income you expect to receive from Social Security and any other income sources, such as a pension. You can use the retirement estimator at www.ssa.gov for a current projection of your Social Security benefit. If you are to receive a pension benefit, your pension  administrator can provide you with an estimate of your income at retirement.


Don't Forget Your Medical Expenses

You also have to plan for medical costs and other unexpected expenses. According to Fidelity Benefits Consulting, a 65-year old couple will spend $275,000 on medical expenses throughout their retirement and that doesn’t include the cost of long term care. In addition, you will need a spending cushion or cash reserve to cover unexpected expenses. The recommended amount to set aside in cash reserve is 6-9 month’s worth of living expenses. Ideally, these additional requirements should be funded separately and added on top of the money needed for your retirement income.


Work Backwards to Find Your Number

One of the more commonly used rules to calculate how big of a nest egg you need is the 4 percent rule. This is the rate at which you can draw down your assets each year without the risk of outliving your assets. The 4 percent drawdown, which should be adjusted each year for inflation, is based on a portfolio with an asset allocation of 50 percent stocks and 50 percent bonds.

As an example, if you and your spouse receive $4,000 per month ($48,000 a year) in Social Security benefits and you need $88,000 to cover your living expenses, you will need to generate $40,000 from your savings. Using the 4 percent rule, you will need to accumulate $1,000,000 of investment assets ($40,000/.04 = $1,000,000).


It's a Continuous Planning Process

The key to making the 4 percent rule work is to make small, incremental adjustments to your withdrawals. You can do this by simply recalculating your withdrawals based on your portfolio value. For example, if as a result of your withdrawals and poor investment performance your savings balance has declined, you could adjust by forgoing an inflation increase or scaling back your withdrawals for a year or two. Alternatively, you could increase your spending or build your cushion during years of increased investment returns. You could also plan more conservatively by using a lower drawdown rate, such as 3.5 percent. It would require a larger investment account balance at retirement, but it accounts for greater uncertainty.

Following established rules and guidelines can be useful for retirement income planning. But, it is important to consider your unique circumstances, needs and attitude about money when developing a retirement income strategy.