Retirement is a big decision for many reasons. “What am I going to do with my time?” “What lifestyle to do I want to live?” “Where do I want to live?” These are important questions, and they all have an impact on another big question: “How much do I need to retire?”
There is no easy answer to this last question. Often, you’ll hear generalizations about the amount of money needed, such as $1 million or $2 million. But the truth is that the answer is different for everybody. Your amount is going to vary based on factors such as sources of retirement income, expenses in retirement, and life expectancy, to name a few. It is important to look at each of these factors to determine how they impact your personal situation and ability to retire comfortably.
What Are Your Retirement Income Sources?
First, examine all of your sources of retirement income:
- Social Security income: This will impact most retirees. What is your estimated benefit at your desired retirement age? What is your benefit if you defer to a later age?
- Pension income: Does your employer offer a defined benefit plan? What is your estimated benefit based on years of service? Is there a reduction for providing survivor benefits to a spouse?
- Deferred compensation: Do you have deferred compensation benefits from previous (or current) employment?
- Rental income: Do you own properties with a steady stream of rental profits?
- Farm income: Do you own farmland with a steady income?
- Part-time employment income: Do you plan to work in retirement?
These are some examples of retirement income, but they are certainly not the only sources. Review your unique situation to determine what is available to you during your golden years.
What Are Your Retirement Goals?
Second, determine your retirement goals. This is where you should lay out what you plan to spend your time on in retirement, and you need to be honest with yourself about what it will cost. Often, retirees are surprised to find that they spend more in retirement than they did while they were working. Hobbies, travel, and “free” time cost money, so it is important to include them in your planning.
It can be helpful to break the spending down and prioritize:
- Basic living expenses (housing, food, clothing, utilities)
- Medical expenses (insurance premiums, out-of-pocket costs)
- Vehicle purchases
- Other goals (hobbies, travels, gifts)
It may also be helpful to look through past bank and credit card statements to ensure that you have an accurate picture of your spending over a full year.
What Is Your Life Expectancy?
Third, determine an appropriate life expectancy to use in your planning. Many factors can impact your life expectancy: family history, personal health, lifestyle choices. It is important to be conservative in projecting life expectancy, and we always recommend estimating longer than average. Medical care is advancing, and it is reasonable to assume that most people will live longer than the older generations of their family. Using 30 years can be a good starting point, but make sure you adjust for your situation.
Determining Nest Egg Size
After answering the three questions above, you should have a clearer picture of the portion of your retirement income that your retirement savings will need to provide.
As a rule of thumb, a good withdrawal rate on your investment assets in retirement is approximately 4% of the annual balance. However, this is a generalization for a moderate investor, and the appropriate amount will vary for each situation. If you are a conservative investor, you should likely use a lower withdrawal rate as future long-term returns will likely be lower on your portfolio than for someone who is more moderately invested.
To determine what size nest egg would create the income you need, use this formula:
Amount of annual income / withdrawal rate = Portfolio size needed
Example: If the annual income needed from the portfolio is $50,000 and the withdrawal rate is 4%, you will need a portfolio size of $1,250,000.
Another consideration is the tax impact on your portfolio income. What type of retirement plan do you have? Is it a traditional IRA or traditional 401(k)? If so, you will need to remember that usually taxes will need to be paid on the amount you withdraw from the portfolio. Because those taxes are generally paid from the retirement account, you will need to add the projected taxes into the planned annual withdrawal when calculating the needed portfolio size.
If you have Roth IRA or Roth 401(k) funds, distributions are not taxable (assuming you’ve met age and time requirements).
If it seems like there are a lot of moving parts to determining how much you need to retire, you’re right! The internet has some helpful retirement calculators that may help you analyze your situation:
It is important that you understand the assumptions that such calculators are using and make sure they align with what you’ve outlined for your plan.
You should also consider hiring a financial advisor that operates as a full-time fiduciary to help you determine a more in-depth plan for your current savings and your future retirement. An advisor can help you navigate all of these moving parts and answer any questions you have along the way.
Contact us for a complimentary needs assessment phone call.