How much money do you need to retire? Of course, to answer this question you must know how to make the best investments to generate income. But more importantly, you’ll find your answer when you understand that successful retirement is more about spending than it is about income. In any case, we’ll handle both these subjects.
Fortunately, to resolve this issue you don’t need to pay someone thousands of dollars to create a fancy financial plan that doesn’t make sense. Go through the following steps to do your own calculations:
“How much money do I need to retire?” To answer that question, I need to know what it costs you to live. I realize that we’re talking about future spending but you must make an educated estimate of what you’ll be spending. My suggestion? Use what you spend now and adjust for inflation. Don’t kid yourself into thinking your spending will decline when you retire. It won’t.
When you retire, you have more time to spend money and you will. You’ll travel more and if nothing else, you’ll shop out of boredom. That’s what happens (unless you fill your day with retirement hobbies that don’t cost anything and could possible make you a bit of extra cash.)
Also, as you get older, you may have to help your kids, grandchildren and you might have added medical expenses.
Most people don’t really know how much they spend but there is an easy way for you to know. A simple method is to average your total bank withdrawals over the last 24 months and keep track of this number. A better way is to use a software package I started using recently called You Need A Budget.
For our example, assume you’ll spend $80,000 a year – as adjusted for inflation. We’re ready for the next step.
When you retire, you’ll have social security and possibly a pension. There are also many overlooked ways to generate income during retirement. How much income will you have?
For our example, let’s assume you’ll have social security and pension income of $30,000. You can see that this person needs to come up with an extra $50,000 in order to meet her annual income needs.
3. Do the Math
We know that this person will need an extra $50,000. Now we have to figure out how much to invest in order to create that $50,000. That answer tells the amount of money needed to retire for this individual. This isn’t difficult to do at all.
Take your $50,000 short fall and divide it by the return you think you’ll earn on your investments over the remainder of your life. I use 5%.
Using 5% might seem like a high number right now. Rates are indeed much lower now but it’s not reasonable to expect that rates and returns will remain this low over the remainder of your life. That’s why I recommend using 5%.
So, if we take $50,000 and divide it by 5% – you get $1,000,000. That means you have to have $1,000,000, and invest it at 5% (over the long run) in order to earn $50,000. You now have your target – $1,000,000.
What have you saved so far? How much will it be worth when you retire?
Let’s say your total savings (including your retirement accounts) is worth $300,000 and you need to get to $1,000,000 by the time you retire in 20 years. Of course you’ll need to make smart investments to reach your retirement goals. But let’s not worry about how to invest the money at this point.
You can use any number of financial calculators to determine what that $300,000 will be worth in 20 years. Let’s assume that you determine that the $300,000 will be worth $800,000. You now know you are $200,000 short.
Again, use any financial calculator to determine how much you’ll need to invest each year, over 20 years with an assumed rate of return, in order to reach your goal of $200,000.
This is not all that complicated if you take it one step at a time and break down the question into smaller questions.
This is an example of a very straight forward case. If your situation is more complex, don’t fret. Many people have various levels of complexity and are still able to run these calculations.
One issue is when your income changes, you start taking out distributions from your IRA, your cost of living shifts dramatically (you pay off your mortgage) and/or a host of other variables.
One of my favorite clients in Arizona created a spreadsheet that ran 15 different scenarios and I was super impressed. He did this all himself with Excel and you can too.
How much do you need to retire? Have you done your calculations?