How much do I need to retire?

watching sunset

Most people I know my age are starting to talk about retirement. Specifically they are talking about when they will retire and where they will retire.

Since I am also thinking about retirement, I will devote a couple posts to this topic. Today’s post focuses on how much do I need to retire.

How to Determine My Annual Income and Expenses?

Everyone is different. What I will need annually when I retire will be different than what someone else will need, but the method to arrive at that number is the same.

1. Start with how much money are you spending annually today. Group your expenses into the following categories; housing (mortgage, taxes, insurance, repairs, utilities), living (food, medical, life/medical insurance), entertainment (vacations, hobbies, going out), auto (loans, insurance, maintenance, licenses), and charity. I track this once a week (saturday mornings) by logging on to the online banking, reconciling my checkbook and entering the expenses into the above categories. You are much more apt to keep your money under control when you have some system to watch over it. I don’t track every penny; the above categories are fine for me. If you don’t know your totals, track it for one month and multiply by 12 (make sure the month you are using isn’t missing any expenses that only fall a couple times per year like car insurance, repairs, vacations, real estate taxes…)

2. Now using the totals from step one determine how much you’ll need in each category when you’re retired. I want to retire when all of my debts are paid off. So my mortgage payment and car payments will decrease. My kids will be grown so I won’t be saving for college. Our insurance for medical and auto should go down as empty-nesters. Our expenses may increase for items like medical, vacations, and hobbies. So adjust these as necessary. Make sure you don’t skimp here. If you want to be a world traveler, enter a large number in your living expense category. If you love to eat don’t enter $1200 a year for food.

3. Determine how much income you will receive yearly.

Social Security – yes I know this is a big “if” but use the following link LINK to figure out how much you will receive.

Pension – if you are lucky enough to be one of those who will receive a pension from your employment, find out from your human resources department how you can estimate your annual pension amount.

Part-time work
– one of the best retirement advice I have heard was to develop a skill that you can use in your retirement years to earn some money. This will take the strain off using your savings and give you something to do so that you don’t spend your days peeking out the window waiting for the mail carrier.

Add these three numbers together.

4. Compare your total from step three to the total from step two. If you’re lucky your income will exceed your expenses. However if you’re like most people you will have a shortfall. This difference will have to be made up from tapping into your savings. Note this difference as we will use it below.

How much do I need to save?

Now that you know the amount of money you will need to pull out of your savings each year we can determine how much your total savings will be.

5. You should only pull out 3%-8% of your savings each year. This will leave the bulk of your savings in investments that will continue to earn for you. Also by withdrawing a smaller amount you won’t have to worry about inflation as much. You will want to be conservative with your investments so your overall return will be lower than when you were younger. Keep seven years of expenses in ultra-conservative investments and the remainder in quality stocks, bonds, and rental property. If you keep seven years of expenses in ultra-conservative investments you will be able to ride out any major stock market crashes. I chose to use 5.5% as my goal for withdrawals as it is right smack in the middle of 3% to 8%.

6. Now take the income shortfall you calculated in step four above and divide it by the percentage in step five. This gives you the total amount you need to save for you to retire.

EXAMPLE

Let’s run through a quick example.

Step one: You determine you are spending $80,000 per year on expenses.
Step two: You estimate when you retire that your expenses will drop to $60,000.
Step three: Your income from social security, pension and a part-time job will be $32,000 per year.
Step four: You calculate you will need to pull $28,000 per year out of your savings ($60K – $32K).
Step five: You only want to tap 5% per year from your savings.
Step six: You calculate you will need $560,000 in savings till you can retire ($28,000 divided by .05).

SUMMARY

Play around with the numbers above. You will find you can change the total savings you need a lot by cutting expenses (eliminating debt before you retire or other expenses) or by increasing your income. Don’t cheat yourself by cutting your expenses so low that you will worry every day about the cost of prescriptions and gasoline… You don’t want to spend your retirement years worrying. Enjoy those years doing what you love and spending time with those you love. Keep these numbers handy and up to date. Having them visible to you will make them more likely to be achieved.

VISUAL MONEY PILOT

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