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How much is enough to retire?

Retirement planning often circles around one primary question: How much money do I need to retire comfortably? The answer to this is variable as it heavily depends on several factors such as lifestyle expectations, healthcare needs, and current age among other considerations. By gaining a clearer understanding of these factors, individuals can make informed decisions about retirement savings and investment strategies to best meet their future financial needs.

In This Insight

Estimating what you need

Before diving in let's take a quick detour to explain what you will find in this article. Answering the question, "How much do I need to retire?" is extremely complex and depends on a wide variety of factors, such as:

  • Your pre-tax, Roth, and taxable account make up.

  • Your health insurance needs

  • Tax credit eligibility

  • Retirement expenses

  • Life expectancy

  • Age at retirement

  • Social Security benefits

  • And much more

Analyzing each of these components can create such a high level of complexity that it becomes challenging to answer the question in a brief article. To provide value for you in a concise fashion, we are going to heavily simplify the calculation into something that is valuable but not precise.

This insight aims to provide a number that is valuable, but not precise.

For a number that is both precise and valuable, we recommend consulting a financial advisor that is both trustworthy and capable. If you're interested, we can help you get matched with a vetted financial advisor.

Understanding the "Retirement Gap"

When planning for retirement, it's essential to understand not only how much money you'll have coming in but also how much you'll be spending. Three critical components to this equation are your projected retirement income, your anticipated expenses during retirement, and what's termed as the "Retirement Gap."

  • Your income in retirement

  • Your expenses in retirement

  • Your Retirement Gap

The Retirement Gap is essentially your income minus your expenses in retirement. For most individuals, expenses will be greater than income and retirement savings are required to plug the gap.

To illustrate, consider you forecast a retirement income of $35,000 annually, primarily from social security, but you aim to maintain a lifestyle costing $100,000 a year. In this scenario, you'd face a Retirement Gap of $65,000, meaning you'll need to draw $65,000 per year from your retirement savings.

The Retirement Gap can be used to provide a valuable estimate for answering the questions, "How much do I need to retire?". As a general rule of thumb, if you divided the Retirement Gap by 4% you'll arrive at an estimate for how much you need to retire in today's dollars.

$65,000 / 4% = $1,625,000

With this number in hand, all that is left is to "inflate" this amount to the year you wish to retire. We recommend using 3% as an inflation number.

Example: You want to retire in 20 years:

$1,625,000 x (1 + 3%)^20 = $2,934,930

Is this method precise? No.
Is this method valuable? Absolutely.

To help you answer this question for yourself, we provided a link to a custom calculator here. You'll need your retirement income and retirement expenses to utilize the calculator, which are explained in more detail below.

Steps to Estimate Your Retirement Expenses

One key step to estimate retirement expenses is to identify and categorize your essential and discretionary expenditures. Essential spending typically involves fixed costs like healthcare, housing, food, and utilities, while discretionary spending involves variable costs such as travel, hobbies, and entertainment. Detailed categorization can provide a better perspective on the proportion of costs that can be adjusted based on financial circumstances in the retirement period. A crucial element in estimating retirement expenses accurately is to consider the impact of inflation on purchasing power. Over time, the cost of goods and services tends to rise, reducing the relative value of money. Therefore, when determining the required retirement corpus, it is pivotal to take into account the erosion of purchasing power due to inflation. This ensures that the accumulated savings for retirement caters to a comfortable and sustainable lifestyle. Additionally, one must also take into account the possible cost of healthcare during retirement. The cost of healthcare is known to rise with age, with a significant part of retirees' expenses being spent in this domain. Hence, while estimating your retirement expenses, it is recommended to allocate a certain portion of your retirement savings to a healthcare fund. This dedicated reserve would help manage unexpected medical expenses without causing undue strain on the retirement corpus.

Steps to Estimate Your Retirement Income

An individual comfortably in a hammock on a beach at sunset.

The initial process to estimate retirement income requires an understanding of the anticipated expenses during the retirement phase. This evaluation should include all costs from basic living needs like food, housing and healthcare, to leisure activities and travels you plan to partake in. Prioritizing these expense categories can help determine the approximate financial requirements for a comfortable retirement. Thus, your retirement savings goal should be based on the total annual expense calculated increased by the projected inflation over the years till your retirement. The second process to estimating retirement income recognizes the importance of income sources during retirement. Common sources could encompass social security benefits, retirement savings accounts, pensions, or even part-time work. Understanding the potential benefits from each of these income sources allows one to evaluate their reliability in covering the forecasted expenses. For instance, the social security office provides a social security statement periodically, detailing the estimated monthly benefits you're eligible for at retirement. The third process involves regular review and adjustment of the plan. Economic indicators such as inflation rates and market performance can influence the value of your retirement savings. Similarly, personal factors such as health condition, lifestyle changes, or career progression can affect your retirement goals. Regular examination of your retirement plan against these varying conditions is vital. It allows for necessary adjustment of savings rates, spending plans, or even retirement age, to meet the desired retirement income goal. It also helps in managing potential risks and dealing with unexpected circumstances efficiently.

"Estimating retirement income involves identifying anticipated expenses, recognizing potential income sources, and continually reviewing the plan to accommodate changes in economic indicators and personal circumstances."

Impact of Inflation on Your Retirement Savings

Inflation is a fundamental component that influences the planning of retirement savings. It refers to the overall increase in the price of goods and services over time while decreasing the purchasing power of money. Often, people tend to overlook inflation when mapping out their retirement plan. However, it is crucial to understand that the buying power of a dollar now will not be the same after years due to inflation. For instance, if the inflation rate averages 3% per year, a bag of groceries that costs $50 today would cost approximately $67 in 10 years. Adjusting your retirement savings for projected inflation can help you assess whether you're on pace to reach your financial goals. There is a common rule of thumb in retirement planning, often referred to as the "4% rule", which suggests that you should withdraw 4% of your retirement savings in your first year of retirement, and then adjust that amount each year for inflation. However, this rule should be used cautiously, as inflation rates can fluctuate and are unpredictable. Having a larger retirement savings or adopting a conservative withdrawal rate can provide a buffer against higher-than-expected inflation. Finally, it is essential to include investments that have the potential to outpace inflation in your retirement portfolio. Typically, stocks have proved to be effective inflation hedges over the long run. However, they come with their own risk parameters that need to be considered. Bonds can offer stability but may not keep pace with inflation over time. The precise allocation among stocks, bonds, and other asset classes should depend upon various factors like your tolerance for risk, your retirement timeline, and your specific retirement goals. Consider working with a financial advisor who can provide tailored advice based on your individual circumstances.

"Adjusting your retirement savings to account for projected inflation is essential to ensure you reach your financial goals as the purchasing power of a dollar decreases over time."

The Rule of 4% in retirement planning

The Rule of 4% is a guideline popularly used in retirement planning to determine the amount one can withdraw from their retirement savings each year without running out. Established by financial advisor William Bengen in 1994, the rule is based on historical data on stock and bond returns over a 50-year span. According to the rule, retirees can withdraw 4% of their total retirement savings in the first year and adjust the amount in the following years based on inflation. Indeed, the appeal of the 4% rule lies in its simplicity. It provides a straightforward formula for individuals to estimate where their financial standing might be in the future based on what they have saved so far. However, navigators of this rule should remember that it was created during a period of high interest rates, which is not the case in the current low-rate environment. Moreover, the rule is predicated on the assumption that you have a well-diversified portfolio balanced between stocks and bonds. Although the rule is alluring in its simplicity, it might not be the best fit for everyone. Factors like personal spending habits, lifestyle changes, economic trends, unforeseen events, and individual risk tolerance can greatly impact retirement funds, thereby affecting the applicability of the 4% rule. Thus, while using this rule could serve as a good starting point, obtaining personalized advice from a financial advisor is often recommended to ensure a more accurate and tailored retirement plan.

Schedule a Free Consultation with Selective

Maximizing the value of your wealth is a complex task that requires expertise across a variety of disciplines. Schedule a free consultation with an advisor that provides comprehensive wealth management, which includes financial planning, investment management, tax strategies, estate planning, and insurance services. Schedule a free consultation today.

Final Thoughts

In the pursuit of a comfortable retirement, it's crucial to account for your expected expenses, potential income, the effects of inflation, and the rule of 4% in planning. Fundamental components for secure retirement encompass not just financial assets but also planning for healthcare costs, lifestyle choices, and income sources like social security and pension. From estimating your projected retirement expenses and income to comprehending the influence of inflation on your savings, every step plays a major role in developing a well-rounded retirement strategy. Remember, the 4% rule can serve as a helpful guideline for retirement spending but like all rules, may need adjustment to suit personal circumstances. Planning ahead will make the journey to retirement as smooth as possible, allowing for peace of mind in your golden years.


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