How Much Money Do I Need to Retire?
One of the most common questions we hear at Investment U is, “How much money do I need to retire?” The answer, of course, depends on a variety of factors and your specific situation.
It’s important to start thinking about funding your retirement as soon as possible. That means if you haven’t started to yet, now is the time.
In this article, we’ll dive deeper into how much money you need to retire and how to help get you closer to your financial goals in retirement.
How Much of Your Current Income Will You Need to Retire?
If you keep a monthly budget of your income and expenses – and you should! – you know how much money you are currently earning and how much you are spending. This will give you a clue as to how much money you need to retire.
The question then becomes: How much of your current income will you still need after retirement? Fidelity, for example, says you should expect to need between 55% and 85% of your pre-retirement income after you retire.
Unfortunately, there’s a big difference between 55% and 85%! So it’s not clear how helpful that advice is. What you do need to do is to look at your specific situation and try to calculate how your expenses may change in retirement.
For example, if you currently have a regular student loan payment, there’s a large chance you won’t be making that payment anymore after you retire. So you can deduct that amount from your current expenses in calculating your expected retirement income needs.
Mortgages, on the other hand, are a bit trickier. While you may be planning to downsize your house or even rent in retirement, many choose to purchase quite luxurious retirement homes.
And if you plan to do significantly more traveling in retirement than you did while working, this can increase your expenses significantly. In fact, you may even wind up needing more income than you currently make!
Saving vs. Investing for Retirement
But the stark truth is, if you have a 401(k), you are an investor. And you need to have an investor’s mindset. Many people who have retirement money beyond their 401(k) choose to put it in savings accounts.
This is a mistake. Of course, you should build an emergency fund for true emergencies, but your retirement savings should be invested. You will make far more money in the long run – even with the ups and down of the market – with a strong investment portfolio.
You should take advantage of other retirement savings options such as IRAs, Roth IRAs, Health Savings Accounts (HSAs) and even taxable brokerage accounts.
The Famous 4% Rule for How Much You Need to Retire
Let’s say you have estimated how much income you need to make in retirement to live the lifestyle you want. How much money do you need to retire, then? How much in savings is actually required?
The “4% rule” is a traditional way of trying to answer this question. The basic rule of thumb states the following:
- The 4% Rule: If you withdraw only 4% of your retirement savings per year, you will never run out of money.
Let’s look at an example. Maybe you’ve determined that you need an income of $75,000 per year in retirement to maintain your desired lifestyle.
In order to figure out how much you need to retire, simply multiply $75,000 by 25.
- $75,000 x 25 = $1,875,000
That’s nearly $1.9 million. Of course, the higher the retirement income you need, the higher the amount of your money you’ll need to save for retirement.
Now, the 4% rule is not universally accepted. There has been criticism, for example, that it may not leave you with enough money in retirement.
One reason for this is that bond yields are nowhere near as high as they used to be. As a result, your income is likely to be lower than desired unless you make up for it with more aggressive and riskier investments.
That being the case, your target savings amount according to the 4% rule might not be a realistic number for you unless you take significant action to boost your income.
Boosting Your Retirement Income
The 4% rule makes the assumption that your only source of income in retirement will be your investment returns. But it is likely that this won’t be your only source. And you should take account of all your income streams when deciding how much money you need to retire.
For starters, you should be receiving social security payments in retirement. While social security is nowhere near enough to fund your whole retirement, it still helps.
Your social security payments should boost your annual retirement income by about $18,000, on average. When added to your investment income, this is a significant boost. But it doesn’t have to be your only one.
There are a number of different retirement income solutions that you should consider. Some of these options are more active, like taking on a part-time retirement job.
But others are more passive, such as renting out some real estate that you own or simply buying an annuity. In general, combining multiple streams of income is often the best way to ensure your financial security.
The Tax Advantages of Retirement Income
Of course, nobody enjoys paying the taxman. But with some of your retirement income streams, you won’t have to! And when considering how much money you’ll need to retire, this should also be taken into account.
For starters, there are tax consequences to receiving social security payments. Low-income earners in retirement don’t pay any social security taxes. And only up to 85% of your social security payment is taxable.
Plus, depending on the kind of retirement accounts you have, your retirement investment accounts may not be taxable, either. For example, if you have a Roth IRA, you already paid the taxes on your gains upfront – no need to pay more now! This can lead to considerable retirement savings in the end.
So don’t forget to take tax consequences into account when you are calculating how much money you need to retire. It can have a major impact depending on your situation.
How Much Money You Need to Retire by Age
It’s never too early to begin saving for your retirement. But the earlier you do so, the better off you’ll be in the end. So there’s no time like the present to get started if you haven’t already.
There are different formulas you can use to calculate how much money you’ll need to retire by a certain age. For example, one formula indicates that you should save 15% of your annual salary starting at age 25. And 50% of this money should be invested in stocks.
By using this strategy, you should have the following amounts saved for retirement by these ages:
- 40 years old – two times your annual salary
- 50 years old – four times your annual salary
- 60 years old – six times your annual salary
- 67 years old – eight times your annual salary.
In order to hit these targets, you’re likely going to need to have a considerable amount of your money invested in stocks.
Now, conventional wisdom says that by your 60s, you should mostly be in low-risk investments like investment grade bonds or government bonds. I take a different view on that.
But ultimately, stocks are the world’s major engine of wealth building and they will do the most to help you secure a happy and wealthy retirement.
Concluding Thoughts on How Much Money You Need to Retire
Saving for retirement can be daunting, especially if you’re over the age of 50. Don’t let it be. It is never too late to begin saving for retirement, and if you haven’t yet, the time to start is right now.
Once you figure out how much income you’re likely to need in retirement, you’ll be able to start figuring out how much money you need to invest – and how aggressively you’ll need to invest it.
How much money is needed to retire is different for every individual and every couple. But this guide should help you start determining how much you‘ll need – and how to get there!
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About Brian M. Reiser
Brian M. Reiser has a Bachelor of Science degree in Management with a concentration in finance from the School of Management at Binghamton University.
He also holds a B.A. in philosophy from Columbia University and an M.A. in philosophy from the University of South Florida.
His primary interests at Investment U include personal finance, debt, tech stocks and more.