Every time I search the internet looking for an answer to the ubiquitous question of “How much money do I need to retire?“, the answers are always just about the same; “It depends“. Yes, it does depend on many things, but very few articles give the details needed to even give a person a starting point. So, I’ll attempt to do just that.
Step #1: Burn Rate
Get your credit card, checkbook, bill pay records, and debit card statements and add up how much money you spend each month for the last 12 months. Round up to create a cushion for the months were expenses may be higher than normal, then divide by 12. That will give you a monthly average of how much you spend each month, called your burn rate.
Step #2: Make the List
The below table is an example of the bare bones expenditures I need to pay for based on prices in the area for which I live. The dollar amounts below are averages per month based on yearly expenses. For example, my car registration is about $200 a year, so each month I need to save about $17 ($200 divided by 12 months = $17).
This is only to get you started and you may need to add or remove items from the below list. Be as accurate as you can, down to monthly subscription costs. It might be helpful to create two lists: the must haves and the wants. Add those costs and compare them to what you got in Step #1. They should be close. If not, make sure you’re capturing all your expenses.
Here are the basic bare bone things I need. This does not include my “wants”:
I’m guessing on some of the stuff because I don’t know how much my medical expenses will be 10 years from now. They could drop a bit once I qualify for Medicare and Medicaid. This list also assumes my mortgage is paid off.
Step #3: Calculations
Based on just the needs above, I would need about $39,300 of after-tax income a year. If I figure I’m in the 15% federal tax bracket, then I’ll need $45,195 of gross income. I must also add State income tax which is about 8% where I live. That means I need a gross income of $48,811 per year to meet my “need” burn rate. If you invested your retirement savings in a ROTH IRA, then you don’t need to factor in the Federal Income tax. Your money has already been taxed at the Federal level.
If while in retirement, I can get 5% returns year after year, then in order to generate an annual income of $48,811 I need a nest egg of about $976,212 ($48,811 / .05). If we lean a little more conservative with a 4% return, I would need $1,220,275 nest egg. This assumes I never draw down my nest egg, but instead live purely off the interest and dividends it generates.
Despite all the hype, I will get social security. Neither political party will allow it to go insolvent. That could increase my income by about $24,000 a year (once I’m eligible). So if I did have to dip into my nest egg early on, it won’t have to generate as much income later in life because I’ll be getting a check from Social Security to help offset the draw down.
Good Things to Consider
If you contribute 10% of your paycheck right now to your 401K, that will stop once you retire, as will your payroll tax contribution of 2.5% (SSDI). So that is less you are “paying” for out of your current paycheck.
You’ll probably be making a little less money once retired than when you were working so your federal income bracket may decrease. You could also retire in a State that has a lower income tax, or perhaps none at all (Florida).
If you can manage it, try to get your mortgage paid off and be debt free prior to retiring. This is really important. Having a mortgage paid off is a lot less stressful. Bottom line is, don’t go into retirement with a lot of debt
Hopefully your kids are employed and living their own life. Food, utilities, car insurance, health insurance and other expenditures should go down.
Not So Good Things to Consider
Don’t think you’ll make the same returns on your investments as when you were employed. Although now is a not a good time to invest in bonds (as of October 2018), in years past, they have historically been a good retirement vehicle due to their stability and descent returns. However, bonds yields today are paying about half of what they were 15 years ago, which is forcing a lot of retirees into more aggressive and vulnerable retirement investments such as equities. Just figure that you’ll make about 5% per year from your retirement nest egg if invested in stocks and mutual funds. Less if you are investing in bonds.
Don’t count on Social Security going up more than about 2% pear year to adjust for the cost of living. And remember, the earliest you can collect is at age 62. So if you retire before then, you’ll need more money until social security kicks in. The longer you wait to start collecting Social Security, the more you’ll get each month.
Inflation is the silent tax. Figure you’ll spend about 3% more each year due to the cost of goods increasing (which pretty much wipes out the social security cost-of-living increase). At the same time, the older you get, the less you do, which means you’ll spend less money. Bingo night may be the highlight event, and that’s usually pretty cheap.
Think consistent and conservative when investing your nest egg in retirement. The last thing you want is to take a 20% hit on your retirement account while you’re withdrawing from it. You want your nest egg to work for you, and you certainly don’t want to go back to work because you invested too aggressively.
I should disclose my investment strategy, for which I have two main goals. The first is, I want to own my home so that I have no mortgage. Second, I never want to pull from the principal investment I have invested while retired. I only pull the interest/dividends generated by the principal. I did it this way because I have no idea how long I’ll live, but I sure as heck don’t want to run out of money later in life. My kids will inherit whatever is left of my nest egg after I pass on.
Again, there are some assumptions being made and the “needs” list above may not be complete, but it’s a starting point to which you can add expenses as you think of them. This should give you a ballpark idea of how to calculate how much money you’ll need in retirement.