How Much Money Do You Need to Retire?

I get asked “how much do I need for retirement?” by people thinking there is a magic number. Of course, no such number exists but there is a process that gets you close. It all starts with determining how much income you’ll need in retirement and today’s post will focus on that.

When you’re within 10 years of retirement, you can get pretty specific because you can do a budget that will reasonably represent your retirement income needs. Add up your current living expenses through a basic budgeting exercise as if you are retiring today. Deduct expenses that may not exist when you retire. Examples include a mortgage that may get paid off, or you’ll finish paying college tuition. Or maybe you’ll get rid of a car. Be sure to add in expenses that may emerge such as increased travel or spending on the grandkids, or increased insurance costs for a few years. Take this budget and increase it by an inflation factor to your year of retirement and you should have a pretty accurate idea of your annual income needs in retirement. For example, you estimate that you’ll need $100,000 per year in today’s dollars when you retire in 10 years. If you assume a 2% inflation rate, then your retirement expenses will be around $122,000 starting in your first year of retirement.

If you are 10 to 40 years away from retirement, it gets less specific. My favorite way to get to your retirement income needs is the income replacement method.  An 80% income replacement means that you would retire at an income level that is 80% of your final years’ salary. For most people, an 80% income replacement would provide for the same lifestyle as their working years. Why? Because you are no longer having to save for retirement and are no longer paying a variety of payroll taxes. Many workers (especially high earners) can retire comfortably on 60% to 75% because they can often ratchet their expenses down a bit in retirement. Others may need 90% to 100% (or more), because their expenses don’t fall much in retirement or they simply have higher spending plans. Let’s look at another example. Assume your current salary is $75,000, you have 25 years to go until retirement, and you have determined you can lower your expenses a little bit in retirement. You have decided a 75% income replacement is reasonable for you.  Using a 3% annual salary increase, your salary at retirement in 25 years would be $157,000. At a 75% replacement rate, you should target $117,750 in income for your first year of retirement.

Determining your income needs is the first step in answering the question at the beginning of this post, which is “how much do I need to retire?”. This is like running a race. You must know where the finish line is, or you’ll simply just be running. Maybe you’ll get lucky and stumble onto the finish line, or you won’t.  Try to estimate your annual retirement expenses and see what you come up with. Here is a link to some financial calculators that will help you (use the budget calculator or the future value calculator). I will address the next steps in my next posts.