How Much Money Will I Need To Retire?

The following is an edited excerpt from the new book, Common Financial Sense: Simple Strategies for Successful 401(k) & 403(b) Retirement Plan Investing by Harris Nydick and Greg Makowski.

This simple question doesn’t have an easy answer.

There are quite a few ideas to contemplate. Some popular reference points are that you will need between 75% and 85% of your current annual income to retire comfortably.

We have found that there are no universal guideposts because everyone’s idea of what their retirement lifestyle will cost differs dramatically from person to person. Some people prefer to have their mortgage paid off on their primary residence. Others want to leverage it to the hilt and take out a long-term mortgage upon retirement. They rationalize that their children and the bank can figure it out when they’re gone. Others rent. You can see how quickly needs are dictated by the specific situations of those involved.

We do know this: What started out as our life’s to-do list morphs into our bucket list over time. This bucket list costs money, whether it’s travel, hobbies or other activities. Very little of what’s on that list will be low cost.

Therefore, you can expect typical retirement financial needs to look like this: the first few years of retirement cost more than 100% of your pre-retirement income. After a few years of traveling and hobbies, people tend to settle into a routine that costs much less than your pre-retirement income. During the last few years of life, expenses tend to skyrocket, as healthcare costs dramatically increase. There are many factors to consider, including assumed rates of return and asset allocation as well as your expected lifespan, to name a few.

The next consideration is how much money, as a percentage of your total liquid investments, you can spend each year.

Many popular calculators assume that you can spend 4% of your principal each year, but of course, that requires regular monitoring, as well. Let’s do some math using this formula.

If you are married and living on $80,000 a year while working, let’s assume you’ll need $64,000 (80% of $80,000) in retirement. As of January, 2016, the average Social Security retirement benefit is $1,341 a month. If both of you are receiving your full Social Security benefit, this will provide approximately $32,000 a year of income. Therefore, you’ll need to fund the difference of $32,000. An investment base of $800,000 at 4% payout will provide approximately $32,000 a year in additional income.

These figures assume that Social Security will continue to pay their full benefits as promised (check your potential benefits by visiting the Social Security Administration’s website at www.ssa.gov).

These figures do not include the effects of taxes or inflation. As we discuss in our book, inflation is difficult to predict, but we must assume that the cost of everything is going to increase over time. Since things are going to cost more in the future, your retirement income must increase at least as much as inflation or your quality of life will decrease over time.

Taxes are another difficult assumption to predict because federal, state and local income tax rates change over the years. You must make some assumptions and monitor them as things change from year to year.

If we take taxes and inflation into consideration, then the 4% payout you are getting on your portfolio must continue to grow over time to offset these ever-increasing costs. The only way for this payout to grow is to have part of your portfolio invested in stocks because they are the only assets that have the ability to grow over time.

For more strategies to make the most of your 401(k) and plan for retirement, check out Harris and Greg’s book, Common Financial Sense.