How Much Do I Need to Retire?
How much do I need to retire?
This is a simple question, but the answer is not so straightforward. We know that you’ll have expenses in retirement, but we don’t know how long you’ll live. Annual expenses multiplied by life expectancy will give you an idea of where to start, but that ignores inflation and other unknowns.
Our client’s monthly expenses vary widely, from a low of perhaps $2,000 month to well over $20,000/ month. Some people spend a lot of money, others don’t. We meet with people all the time who are making good money and spend it all and then some. We also meet with folks who earn very little and still manage to give away a large % of their income and save.
One of the first questions you need to answer in constructing a financial plan is how much money do you want/need in retirement? If you get everything else right, but mess this up you might still run out of money.
Regularly people currently spending six figures a year will say they are going to live on $3,000- $4,000 a month in retirement. While we have clients who live on that in retirement, cutting spending by a third, half, or more is a big adjustment. Is it realistic to go from spending $150,000 a year to spending $50,000?
Maybe – that’s up to you. That’s a big adjustment though. That’s going from $50.00 a bottle wine to boxed wine. That’s no more going to the movies, no more vacations, and a lot less eating out. To some people the adjustment is worth retiring sooner. To others, it isn’t worth the sacrifice.
If you don’t know what you are spending, you don’t have to itemize everything to determine how much you are currently spending. The easiest way to know what you spend is to look at deposits over the course of a year. Add those up. Deduct any explicit saving you are doing from your bank account. For example if you deposit $10,000 and then send $1,000 from your bank account to a separate savings (that you don’t later spend) or to an investment account, back the savings out of the deposits. Back out principal and interest on your mortgage if that will be paid before retirement. Back out any other expenses you currently have that will go away in retirement (children’s education expenses, weddings, cars, insurance or cell phones for the kids…).
Once you’ve added up all your deposits over the course of a year or two and backed out the items that will go away, you’ve got a decent starting point for continuing your existing standard of living. Now you may need to look at adding in any additional health care expenses. For example, if still working you and your employer are probably splitting your health care insurance premiums and its costs did not show up in the above exercise. Map out how much your health care insurance premiums will be in retirement and add them in. If you want to get really granular, look at Quicken or Mint.com. Mint.com is a free web service that I recently started using. It pulls account data from all your banking, investing, and credit card accounts. It will tell you exactly what you spent and what you spent it on. For those worried about security, Warning – Using Mint can be very sobering and lead to all kinds of marital difficulties. There’s no hiding how much you spent on specialty stink bait flown in from Africa or what you spent on shoes last month.
OK, now you should have an idea of what you need annually in retirement. You have an annual spending number. Now what? Now we have to figure out how you are going to get that annual number every year. A rule of thumb is that you should only withdraw 4% of your investments annually in retirement. Some have argued recently that the 4% rule is no good anymore because of low interest rates and longer life expectancies, but it is still widely used. Map out your guaranteed income sources like social security, any pension or annuity income. Subtract your total income need from your guaranteed income sources and multiply the shortfall by 25.
Example: current spending of $6,000/month.
In retirement additional medical insurance premiums of $600/month for a total need of $6,600/month of net spendable dollars.
Let’s assume social security of $30,000 annually and that you’re effective income tax rate is 20% in retirement.
We multiply $6,600 X 12 months = $79,200 and divide that by 0.8 to get the pretax income need of $99,000.
Next subtract the social security of $30,000 =$69,200 shortfall.
Multiply that by 25 = $1,730,000.
With that amount this couple could abide by the 4% rule or said another way they could park their $1,730,000 in cash and spend 4% per year and it would last 25 years. If invested wisely, perhaps it never runs out.
What if they don’t have $1,730,000?
- Work longer and delay taking social security to get a higher benefit
- Change lifestyle to reduce spending
If you want some help mapping out your financial plan, we’re happy to help. Often we can help you improve your financial picture just by helping you see the big picture and how all the little decisions fit.