You may have asked yourself: How much do I need to retire? It is one of the most common questions leading up to retirement and there are a few different ways to calculate this number.
- Pre-retirement Income Replacement (70 – 90%)
- 4% Rule or 25 Multiplier
- Current Age and Income Multiplier
#1 – Pre-retirement Income Replacement
One of the most common ways to figure out how much you’ll need in retirement is to use the pre-retirement income replacement method. This method is very simple: take your current household income and multiple it by between 70 and 90% based on if you’ll carry a mortgage in retirement or not.
For example, if you and your spouse are both 60 years old and have a current household income of $100,000 annually, then you’ll want to have between $70,000 and $90,000 in annual income in retirement.
But this still doesn’t answer how much do I need to retire. To figure this out, you’ll need to know how many years you’ll spend in retirement and the expected interest rate you’ll receive on your portfolio.
It’s also a good time to account for Social Security and any pension income prior to calculating the amount you’ll need to save for retirement. You’ll be receiving Social Security and you may also have a defined benefit plan. You’ll need to subtract these annualized payments from the 70 – 90% number you figured out above.
For example, the annual income we figured out for the couple above in retirement is between $70,000 and $90,000. Assume this couple will collectively receive $35,000 annually for Social Security and $15,000 from a corporate pension. Now the number of income the couple needs to generate drops to between $20,000 and $40,000.
After you figure out the net number (the number with Social Security and any defined benefit plan pension), multiply that number by a factor in the chart below (assumes a 4% inflation rate):
In our above example, the net number is $20,000 to $40,000. Let’s say we expect to be in retirement for 25 years and expect an 8% return on our investments. The number “how much do I need to retire” equals between $329,800 and $659,600.
What if I don’t want a range?
Choose a number and make it concrete. Choose 80% (or other percentage) as the number you want your retirement income to be as a percentage of your pre-retirement income. That would make the amount you need to have exact. In the above example, the amount you need to retire would be $494,700 ($30,000 net annual income times the 16.49 factor in the above chart).
You just performed your own retirement calculation and you didn’t have to adjust for inflation. The annuity factor chart above does all the adjusting for you.
Now, want it to get even easier? Download this spreadsheet to calculate the amount of money you’ll need to retire based on your specific retirement situation.
The spreadsheet is simple to use and contains only four user input cells. It generates an amount you’ll need to retire based on:
- Your desired retirement income level
- The rate of inflation which is currently 3% but using 4% in the spreadsheet to be conservative. You can use any amount you wish.
- The expected return on your investments
- The number of years you plan to spend in retirement
When you reduce the amount you need annually by Social Security and any pension income, the amount you need to retire becomes much more manageable.
#2 – The 4% Rule or the 25 Multiplier
How much do I need to retire using the 4% Rule? The 4% Rule is simple to understand and is based on the premise that your portfolio will last forever if you only withdraw 4% per year.
The 4% Rule: If you withdraw 4% of your portfolio per year in retirement, your money will last forever.
That’s great to know but if 4% only covers half of your living expense, it’s no bueno for you.
So what you can do is take the inverse of the 4% Rule – the 25 Multiplier Rule. The amount you’ll need to retire equals your annual living expense in retirement multiplied by 25.
As in #1 above, you’ll want to take the net number after Social Security and pension income
For example, the net number in our example above is $30,000 ($80,000 in annual income needed minus $35,000 in Social Security income minus $15,000 in pension income). Applying the 25 Multiplier Rule yields $875,000 as the amount you’ll need in order to retire.
Why is this number so much larger than the results in #1?
The 4% Rule keeps the principal of your investments intact; your money will last forever. This is a great rule of thumb for those who wish to leave money to their heirs.
Why is 4% the Magic Number? Why not 2 or 10%?
4% works well because the average return you can expect to receive on a diversified portfolio is 7% and the current rate of inflation is 3.1%. The real return (after inflation is 4% rounded).
4% is a sustainable amount you can withdraw based on your expected return and the inflation rate.
It also happens to coincide with the amount you can expect to receive in dividend and bond income on your diversified portfolio. This means that you may not even have to sell your invested securities. You can simply withdraw the dividend income and bond income that your portfolio generates.
#3 – Current Age and Income Multiplier
How much do I need to retire based on my current age?Many wealth management firms recommend having the product of a multiplier and current household income as the amount you’ll need for retirement. This works especially well for younger families to see if they’re on track for retirement.
For example JPMorgan Asset Management recommends that households have an amount saved based on their age and current household income. The chart below shows JPMorgan’s recommended multiplier:
For example, a 60 year old couple with $100,000 in combined income should have $730,000 saved for retirement.
Go to page 15 on JPMorgan’s Guide to Retirement for the assumptions they use to get the multiplier.
Quick and Dirty Net Worth Calculation
This kind of calculation is similar to the quick and dirty net worth multiplier. This rule states that you should have as your net worth your current age times your current income divided by 10.
For example, a 40 year old with a current income of $100,000 should have $400,000 as a net worth (40 x $100,000 = $4 million / 10 = $400,000).
They don’t call this the quick and dirty net worth calculation for nothing! Actually, I’m using quick and dirty so not sure if it’s actually called this but it should be.
I think that this rule is skewed a bit. It really over estimates the amount should have at a young age, say below 45, and under estimates the amount you should have at a higher age.
But if you want a calculation you can use at a party, go ahead and break out the quick and dirty net worth calculation. Just don’t be alarmed when people’s eyes glaze over out of sheer boredom.
Using an Online Calculator
There are many online calculators and your current investment provider probably has one available to you.
Personal Capital provides a great retirement planner tool under the “Advisor Tools” menu. Two things are great about using Personal Capital as a retirement calculator:
- You can link it to your accounts (401(k), IRA, Savings, etc.).
- The software tool stores your data so you can reference it as needed.
Here’s a sneak peek at the retirement planner tool:
Bankrate’s Retirement Calculator is fairly simple to use although doesn’t give you the amount you’ll need for retirement versus what you’re currently on track to have like the Vanguard Retirement Calculator.
You can adjust for different rates of inflation, expected return on investment, and the tax rate.
Vanguard provides a pretty simple calculator and also includes an option to input your Social Security benefits and pension income at the bottom.
Will I have enough to retire?
If you’re asking yourself “how much do i need to retire?”, you’re logical next question will be “will I have enough to retire?”
If you’ve run some of the calculations above and you aren’t able to generate enough income in retirement, there are things you can do to generate more income.
Here’s the list of things you can do if you’re not meeting your financial objectives:
- Work longer (an obvious choice if you don’t have the money to retire).
- Make sure you’ve lowered expenses that you won’t have in retirement.
- Run the numbers on claiming Social Security earlier and withdrawing from retirement accounts later versus withdrawing from your retirement accounts earlier and claiming Social Security later (maybe even waiting until age 70)
- Increase the risk you’re taking on your investments. A lot of people want to reduce risk in retirement but if you can’t generate the income you need, look into increasing risk. There is a direct correlation between risk and return and you can easily adjust this factor.
- Hire a fee-only financial planner to help get you on the right track. They can take an objective look at your finances and give you the strategy you need to retire.
Don’t get discouraged if you’re not meeting these financial objectives. One or two good years in the stock market could give you quite a boost. Of course, that also means that if you’re in good shape, a couple of bad years in the market would hurt you.
But ask yourself this question, “will the market be higher in 10 years than it is today?” If the answer is yes (and it always is), then you need to have your money in the market. Now it can be tough when you lose money in the market, even if it’s just on paper and you haven’t realized the losses.
Asking yourself the “10-year question” is great to do because by doing so, you’re forcing yourself to take a long term view of investing.
You wouldn’t sell your house just because it may go down in value next year. You know that in 10 years your house will probably be worth more than it is today.
If I went to my wife and told her we need to sell our house because it’s likely to go down in value next year, she’d probably roll her eyes and think I’d finally lost it. Don’t make this mistake with investing either.
“Time in the market is more important than timing the market.”
How Much Do I Need to Retire Conclusion
There are some main rules of thumb and calculations that can guide you when figuring out how much do I need to retire.
To figure out how much you’ll need to retire, download this spreadsheet and input 4 variables outlined in step #1 above.
Use the 4% rule to know how much you can safely withdraw from your retirement portfolio. You may be able to simply withdraw your dividend and bond income instead of tapping your principal.
To see if you’re on track for retirement, use the current age and income multiplier described in step #3 above.
Make sure you’re incorporating an estimate of your Social Security income in retirement and any pension or other income.
Think about reducing your expenses but there are options to increase your income. You shouldn’t have to retire as a pauper. If you optimize your retirement income, you should be able to generate 70 – 90 % of your pre-retirement income in retirement. How much do I need to retire is an easy question to figure out if you know the amount you’ll need in retirement.