How Much Savings Do You Need To Retire?

December 4, 2018

  • The simple retirement calculator chart below shows how much retirement savings you will need if your goal is to retire at either age 55 through age 75.

  • To calculate your retirement savings need, you need to decide on your retirement age, your life expectancy and your desired retirement lifestyle. You also need to assume an inflation rate and an investment rate of return.

  • Always approach retirement calculations with caution, using the most conservative estimates meaning the lowest rate of return and longest possible life expectancy.

I talk to people in their 20s and 30s all the time about their future. One of the top financial questions they ask is how much they will need to retire. They are looking for a magic number, at age 65, is $500,000 enough? Do I need closer to $1,000,000? Can I get away with just $100,000 if I move to Mexico?

The question is a challenging one since advisors need to account for so many variables, most of which are unknown. For example, what is your lifestyle, and do you want to maintain it during retirement? Are you comfortable downsizing? Or do you envision traveling in luxury which would mean you would need a lot more, not less? A couple I worked with recently fell short of their savings goal by age 65, so they moved to South East Asia to retire due to the lower cost of living.

A rule of thumb often used in the financial planning industry is that you need 10 times your current annual earnings in savings. So, if you make $50,000 a year, you need $500,000 in savings by age 65 – or whenever you plan to retire.

I think you can do better than rely on a “rule of thumb”. The best way to figure out the correct savings amount is to assume that your goal is to retire at the same basic lifestyle level compared to where you are now, when you are still working. The assumption is that a family making $100,000 a year before retirement, will want to continue making $100,000 after retirement. That may not be your wish, but it’s a place to start running numbers, and for younger investors, a good goal to set.

The Decisions

My goal is to give you a dollar amount that you can set as a goal. Remember, I would rather shoot for a goal greater than what I really need, so keep that in mind when you see the results below.

Decision 1: Income

Decide on what annual income you will need in retirement. Set a higher number rather than a lower number. If you end up with too much savings, you can always leave it to your kids.

Decision 2: Retirement Age

You need to decide when you are going to retire. Be realistic. Age 55 may sound enticing, but it would take a significant sacrifice now to save enough by such an early age. I worked with a client recently who asked me what he needed to do to retire at age 55. He was 54, had zero savings, had never even heard of a 401(k) and wanted to know what he needed to do in the next 12 months to retire. Age 65 seems to be the right age most are shooting for, but many financial experts are now recommending retirement at closer to age 70.

Decision 3: Length Of Retirement

How long do you think you are going to live? This is huge, because it helps determine the number of years you will need to maintain the income level you are shooting for. If you retire at age 55, and expect to live to 95, you need to plan for 40 years of income. At $100,000 a year, that’s $4 million!

On the other hand, if you family history is such that your expectation is only 85, and you plan to retire at 70, you only need to save enough for 15 years, or $1.5 million for the same $100,000 a year.

So how do you know how long you are going to live? You don’t, so you should always project a longer lifespan just in case. I normally assume life expectancy to age 95 but for people who’s parents are already older, projections can be pushed out past age 100.

Decision 4: Inflation Expectation

Let’s say you are planning a 30-year retirement at $100,000 a year. You need $3,000,000. That’s a start, but the calculation is not that simple. Over 30-years of retirement inflation could have a significant negative impact, degrading the value of your annual income. Therefore, you need to assume you are going to increase the annual withdrawal from your accounts annually. For example, if you assume an annual inflation rate of 2%, then you would increase your $100,000 withdrawal to $102,000 in year 2. In year three, you would increase the withdrawal to $104,040, drawing your account down faster than you may have expected.

What is the right inflation rate? No one knows, but the Federal Reserve has set 2% as their inflation target, so that’s a good number to use for projections.

Decision 5: Future Investment Growth

Just because you’re retired, doesn’t mean you stop investing. After each annual withdrawal, the remaining balance is still invested and still growing. The rate you choose is based on your risk tolerance, but I suggest, when making projections for multi-decades into the future, you project conservatively rather than aggressively.

The chart below assumes growth rates of 3% and 6%. I discuss more on how why I use these numbers later in the article.

The Calculation

So how much do you need to retire? Pick a retirement age on the chart below using the 3% growth rate assumption. Next, find the annual income you think you will need, and you have your goal. For example, if you plan to retire at age 65 and you think you need $50,000 a year, you should be shooting for total retirement savings of $1,344,000.

If that sound like a lot, remember, this is just a guide, a goal to set. How you get there is the subject of additional articles on this blog.

Another consideration is the fact that you will have additional sources of income in retirement. If you think the $50,000 a year goal is a good one, remember that the average American will receive about $17,000 a year in Social Security (based on 2018 national averages). So that drops your need to $33,000, and brings your savings need to about $890,0000.

Why such low rates of return?

I show the 6% growth rate assumption, so you can see the difference, but I would be carful using such a high rate of return. 3% growth during retirement is much more realistic. When you are retired, you need to assume you will be investing much more conservatively than you were when working. You will have no new source of revenue coming in, and you won’t be able to replenish your reserves if there is a significant decline in the market. For the past 10 years, rates of return in low risk fixed income strategies have been low compared to historical averages, and you should assume that will continue to be the case indefinitely.

Additionally, when projecting anything for decades in the future, especially when your lifestyle in on the line, you should assume your return will be lower rather than higher. Overly optimistic returns can easily give you a false sense of security in your ability to meet your future obligations. If you over project and over save, great, you are better off than you need to be.

Investors as well as advisors who want to win your business tend to be overly optimistic in their projections. I have seen rosy retirement projections from seemingly legitimate financial planners who project out 30-year plans at growth rates of 14% or higher. At no time in history has any conservatively invested portfolio been able to maintain that type of return over long periods.

The chart below shows historic rates of return for two common investments, the stock market and the United States 10-year treasury. The stock market, based on the Standard & Poor’s 500 index, is historically one of the best long-term investments you can make. But you can see from the chart that in the 20-year period leading up to the end of 2017 (the most recent as of this writing in late 2018), it has an inflation adjusted rate of return of only 4.84% – and that’s including dividends and ignoring the negative effect of taxes. The 10-year treasury is the benchmark low risk investment and it only has an inflation adjusted return of 1.57%. Worse yet, I haven’t even subtracted average mutual fund and retirement plan administrative fees from these rates of return!

Is there anything else I need to consider?

First, you need to consider your future healthcare costs, and add that to the annual income you are planning for. Also assume healthcare costs will be higher than they are currently. According to Barron’s, the average couple will spend $260,000 on healthcare costs during retirement. So, if you were planning to live off that $1,000,000 retirement nest-egg, remember a quarter of it will go to ensuring that you have access to health care services. Plan on needing more rather than less.

Second, you need to consider long-term care costs. Long-term care refers mainly to the need for assisted living care or nursing home care and could easily cost over $8,000 a month. While the average stay is less than 4 years, that could still add up to $384,000.

Third, while I’ve considered inflation after retirement by increasing the annual withdrawal by 2%, I haven’t considered inflation between now and retirement age. If you are 35 now, and plan to retire at 65, you may be shooting for $50,000 a year, but how much is that going to be worth 30 year from now? To account for inflation before retirement, save based on a percentage of your income, not a dollar amount. As your salary increases with inflation, the dollar amount of your savings will increase (more on this in future articles).

What about taxes?

In all the above calculations, I have ignored taxes. The reason is that taxes are largely the same after retirement as they are when you are still working. You read that right, tax rates don’t go down just because you’ve retired. While you won’t owe any more payroll taxes, you will still need to pay Federal and State income taxes, and all the other sales, property, utility and auto taxes, and everything else you pay now.

Additionally, here’s something many don’t consider. Even if you make less during retirement than when you were working, you can’t assume that your tax rate is lower because you will have lost many of the deductions you were used to taking such has mortgage interest, child credits, dependent care expenses and deductions for the contributions to retirement plans you are no longer making.