How Much Do I Need to Retire?

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Nest egg savingsOne of the most pressing questions many people ask is this: How much do I need to retire? This questions haunts many people. Trying to decide how much you need to retire isn’t particularly easy, since it depends on how long you will live — and no one knows the answer to that question.

The common rule of thumb is that you can withdraw 4% from your account each year if you expect the money to last indefinitely. This amount is used because it assumes that your investment portfolio will beat inflation and keep growing, and it is considered a conservative estimate. If your investment portfolio manages to return 7% annually, you are “safe” if the inflation rate is 3% annually and you are withdrawing 4%. It’s supposed to even out. (Of course, if your portfolio doesn’t return that each year, then you end up dipping into your capital.)

However, deciding how much you need annually — whether you use the 4% rule of thumb or not — depends on your individual needs. Here are two ways to look at it:

Building a Nest Egg

One of the most popular options is to build a nest egg that is large enough that you can live off the interest. In order to do this, you first need to figure out how much you expect to need during the year. Many people like to say that you are likely to only need 75% to 80% of what you spend now. This assumes that your home is paid off, along with other debt. Personally, I think you should plan for needing at least 100% of what you need now, in order to counter rising health care costs, and the possible expenses associated with travel and hobbies.

Look at your current expenses, including housing, utilities, food, entertainment, and other items. If you want to maintain the same quality of life, it’s a good idea to just assume you’ll spend at the same level (although what you spend your money on could change). If your expenses amount to $45,000 a year, you will need a nest egg that allows you to withdraw at 4% (earning at least 4% interest). You can find that as follows: 45,000 / 0.04 = $1.125 million.

Of course, that doesn’t include the cost of inflation. But, as long as you keep your costs to $45,000 a year, and your portfolio is earning 4% interest, then the money should last indefinitely. If you want to just make sure the money lasts 20 years, and you don’t care about what’s left over, you only need $900,000. Any extra you end up because of interest is just a bonus.

Creating Monthly Cash Flow

Another method is to create monthly income to help pay for your retirement. You still figure up how much you will spend, but you look at it on a monthly basis. In our example, you need $3,750 each month. You can work on building a nest egg that provides part of that, but you can also look for other ways to get that $3,750. Estimate your likely Social Security benefits. You can also build up passive sources of income, such as dividend stocks, web earnings, or some other business, to help you create cash flow. You can still use your nest egg for monthly income, too, but the need for a huge nest egg is smaller if you have cultivated income diversity.

Ultimately, what you need to retire depends on the lifestyle you want to lead, and how long you want to be able to lead it. The more you want to do, and the longer you expect to do it, the more money you need to retire.

(Photo: RambergMediaImages)

{ 6 comments, please add your thoughts now! }

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6 Responses to “How Much Do I Need to Retire?”

  1. Kenny says:

    Retirement Calculators are abound on the internet. The issue I have with them, is that they are either TOO simple and use too many standard numbers that apply to 100million people, or they are so detailed that you get over-whelmed just looking at the first page of the XLS file. I am talking about ‘free’ versions only here (web based on XLS based).

    The 2nd issue is that most people do not know how much the spend, and also, is unsure what % of that number will be needed after they retire.

    I just met with 3 other friends who are within 10-15 years of retirement (like me) and asked a few questions on the above number, and we could NOT come to an agreement. And, we all have similar jobs, backgrounds, income levels, asset levels, life-expectancy (+/-), and families.

    So, in short, doing the macro level thinking as mentioned in this article makes a lot of sense, and then figuring out each of our own numbers (I have come close to these numbers after working hard to compute them over the last 3 years), and projecting it out.

    Taking conservative numbers like 5% net-effective-return on investments as we move into a high inflation era (soon), will be a good thing. Also, ensuring that we do not over-estimate how many years we will work, and how much Social Security we will get (depleting fund), is importantly. Cost of Medical Care (even with Medicare Part A, B, C and D), will be different, and there might be the full 26 alphabet letters soon after Obama is done, is going to need some ‘backup plans’.

    Just some quick thoughts……


  2. Fabclimber says:

    Can’t I just borrow four out of ten dollars that I spend like the Federal Gov’t does?

    Sure would make my retirement better!

  3. Jaye says:

    For several reasons I’ve started being embarrassed to say my monthly SS check covers ALL my expenses with about $400 extra: 1. Most people seem shocked that I could live on less than $2000 a month 2. That I have discretionary income out of it 3. That I’m OKAY with it and 4. That I manage to do it at all.

    Yes, folks, I have the obligatory 401k which I do not use because SS is enough!
    I do not need a million dollars, just enough to pay the bills and recreate now and again

    • PawPrint says:

      Jaye, would you ever feel like writing something about how you do this? My father was able to live on his SS, but he let his house fall into disrepair, never bought clothes, never traveled, etc. That was, however, a personal choice because he didn’t like to travel, didn’t care about clothes, and was rather miserly. I don’t want to live like that, but then again I don’t need to cruise the world either. I just want to live comfortably, travel to see my kids, and get good medical care when I need it. The unknown variables bother me.

  4. Cindy says:

    Jaye, that’s fantastic! I hope I end up in the same situation when my retirement time comes for starting soc sec!

  5. I think Kenny’s issue No 2 is key here – most people really do not know what they spend their disposable income on. They may know the bills, but what they spend on food, clothes, entertainment etc etc can add up on a daily basis without us really realising it.

    So perhaps, by looking at the future this way will help us or force us to look at our spending and help us make better choices and better decisions about our way of life.

    I have been through this many times (every year in fact) as a self employed young woman. It empowers me to know where my hard earned money is going, and my future is not so scary as I am a better position to plan for it (or not!).

    If we took better control of our finances, we would have better control of our spending, risks, and ultimately our futures. Just my 2 € cents 🙂

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