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How Much Do I Need to Retire?

One 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 [3]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 [4], 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 [5])