The question I’m tackling in this post and video is an important one. In fact, it was the most Googled question in 2020. It deals with retirement, and the question is:
How much do I need to retire?
If you’re like most people, you’ve asked yourself—and a few others too—some version of this question.
Today, I want to answer it the way any good attorney would: It depends.
I know what you’re thinking: “Depends on what?” That’s another good question! Let’s examine a few factors that determine how much you’ll need in retirement.
What one big investment company says
Fidelity Investments has an article on its website titled—appropriately—How much do I need to retire?
Their guideline is that by age 67, you’ll need 10 times whatever your income is. Their recommendation is to make it your goal to have retirement savings equal to your salary by age 30, three times your salary by age 40, six times your salary by age 50, eight times your salary by age 60, and 10 times your salary by age 67.
The article makes some interesting points, but one thing that stood out to me was down in the fine print. This is the part that most people probably aren’t reading, and it has to do with the percentage of income replacement that Fidelity is assuming for their example.
The fine print says that Fidelity analyzed the household consumption data for working individuals aged 50 to 65. From the Consumer Expenditure Survey conducted by the U.S. Bureau of Labor Statistics, the average income replacement target was 45%, and that’s based on the objective of maintaining a similar lifestyle before retirement. For a below-average lifestyle, the target is 35%. For an above-average lifestyle, the target is 55%.
This is where I haven’t seen the numbers play out with the clients that we work with.
What we’ve seen with our Christy Capital clients
Fidelity is suggesting that in retirement you only need to replace 45% of the income you’ve been getting prior to retirement. To us that number seems low.
Most of the people that we work with want to retire and continue spending at the level they were spending prior to retirement.
For that reason, instead of focusing on income, we think it’s better to focus on spending. Think about it this way: You don’t spend 100% of your income now. Right off the top, a portion of your income goes to pay taxes, some goes to health care, some goes to fund your TSP or other retirement accounts, etc.
So, a wiser way to come up with how much you’ll need to retire is to do some math on your spending habits. (Here’s where a pen and paper will come in handy.)
Calculating what you’ll need to retire
Ask yourself: “How much money does it take each month to run my household?”
To get an accurate figure, look at your bank statements. Look at your credit card statements. Try to figure out over a three-month or six-month time period “How much does it cost to run my household? How much am I spending each month?”
Let’s say, for example, your calculations show that you’re spending $6,000 per month.
Great. Now, let’s look at the income sources you’ll have in retirement.
Some people will have a pension of, let’s say, $2,000 a month after taxes. If you’re one of those people, write down the amount you’re expecting to get.
At some point, you’ll also be collecting Social Security. How much will that be? If you don’t know, you can go to ssa.gov and check your account. In our example, let’s say you’ll be receiving $2,200 a month after taxes in Social Security benefits. So, now we need to do a little math.
Take the $6,000 in monthly expenses you’ve got. Subtract the $4,200 of monthly income that you’re expecting to receive. That leaves you with a $1,800 shortfall each month.
Making ends meet
Most people make up this gap between retirement income and retirement living expenses either by continuing to work part-time in retirement or by taking distributions from the retirement assets they’ve accumulated.
Let’s assume you have no desire to keep working; you want to fully retire. Fantastic! But that means you’ll need to withdraw $1,800 a month from your “nest egg.” Here we need to do some more math.
The conservative withdrawal rate in the industry is around 4%. That means you could withdraw 4% of your money annually, and your account should not run out of money. This formula makes sense because if you withdrew 4% out of assets each year, it would take 25 years for you to run out of money—and that’s if you’ve never earned a single penny on your retirement assets.
If, however, you could earn a modest 4% on your money, then you’d only be taking out the earnings. Your nest egg would be untouched. With reasonable earnings, a 4% withdrawal rate should not cause you to run out of money.
Here’s what those distributions would look like. If you multiply $1,800 a month times 12 months, you get $21,600 per year that you’d need to withdraw from your retirement assets.
Don’t forget the “t” word!
But wait! We have to remember taxes. Retirees aren’t exempt.
If you’re in the 22% federal tax bracket and the 5% state bracket, that would mean you need more than $21,600. You’d actually need to withdraw $29,589—almost $8,000 more—to pay the taxes you owe.
So, to figure out the total assets you’d need to be able to take such a distribution annually, we have to do a simple calculation: Divide that $29,589 figure by 4% (.04).
This gives us a balance of more than $739,000. In short, that’s how much money you’d need in retirement assets to be able to take the size withdrawal we’ve just discussed.
What if you don’t have a pension?
In the example just given, we used a pension in our calculations (plus Social Security). But what if you won’t be getting a pension–only Social Security? Then we have to take that pension income out of our equation. That means you’d need to withdraw around $3,800 a month from your nest egg to live on.
That would mean withdrawals of more than $45,000 per year—plus taxes, which would bring the total to $62,465 a year. Using our 4% withdrawal rate formula, you would need over $1.5 million in retirement assets to be able to live in retirement at the same level you’re living right now.
Let me note that the math we’ve done here is an oversimplification. It’s only designed to get you in the ballpark of how much you’ll need to retire. It’s possible to get an even better assessment.
What’s a “full financial blueprint”?
If you’re thinking, “I could use more help figuring out all these retirement details,” may I suggest a “full financial blueprint”?
With this more detailed analysis, we enter the amount of money that you are wanting to spend each year in retirement. We input your pension—if you have one—your expected Social Security, and your spouse’s Social Security benefits too—if you’re married. We look at your retirement assets and show you different growth rates on your investments as well as different tax rates.
Going through this process doesn’t give us any guarantees. There are assumptions made in this plan. And, as we all know, life doesn’t always play out according to plan. But this blueprint can get you—and keep you—close. Especially when you consider that each year, we work with our clients to update their plans.
Some years our clients earn more than their plans estimate. Some years they spend more. Life happens, and that’s okay. The good news is that by constantly monitoring and updating your plan, we can alert you when things start heading off course.
For example: When you have multiple years of taking out 10% or more from your assets, it’s a warning signal. When your returns are way off for several years, that’s a warning signal. If tax brackets change for the worse, that can affect your plan. We monitor all that.
A full financial blueprint is wise because retirement is too important to mess up. And if you’re uncertain about going at it alone, and you want to work with a team that understands these things and helps people every day move closer to their retirement goals, please reach out.
