How Much do You Need to Retire

How Much do I Need to RetireHow much do I need to retire? There’s not a one size, fits all answer to that question. Some will have a pension, some can rely on social security, but most will need other assets. Usually, when someone asks that question, they’re wondering how much in personal assets they need before they can retire.

Definition of Retirement

Retirement to some means they no longer work. Since some are wondering how much they need to be financially independent and others are wondering how much they need in order to quit their current job, I will discuss all of these. Instead of wondering how much you need for retirement, we will go over some scenarios to determine how much you need in order to stop working at your current job, whether you want to retire, because you’re financially independent, or to work part-time.

Spending in Retirement

You need to determine how much you will spend each year after you quit your current job. To do that, start with your budget. Your budget tells you what you currently spend each month. Since you will no longer need to save any money, you can ignore that amount. If your budget is currently $4,000 a month, you are debt-free and are currently saving $1,000 a month, the money you need in retirement for your living expenses is $3,000.

Let’s assume you also want to spend a little more on traveling during retirement then you were during your working years, so let’s add another $500 a month to this figure. Some of this money may be taxable to you. You need to estimate how much tax you’ll owe on this money. You need to consider additional healthcare costs the older you get. If you have been neglecting your physical life you need to consider adding more for healthcare. There’s no better time to start eating right and exercising then right now. In our example, let’s say we need $4,000 a month.

For all practical purposes, don’t think you will spend less in retirement than you are spending now. If you cannot live now without a new car payment, you won’t give up the habit in retirement, and your continued debt will hold you back. Now is the time to form good financial habits.

Most financial planning advice says that you will spend 85% of your gross income in retirement. They derive this figure from the fact that you will not pay social security tax or federal income tax on your investments, or at least be in a lower tax bracket. The problem with this method is it assumes you spend all your income now and don’t save any of it. Unless you already have enough saved in order to spend all your income now, you will have a rude awakening when you decide that you want to retire.

After you determine how much you will spend in retirement, you now need a plan to fund that amount.

Social Security and Pensions

Some of you will receive social security, and some of you will have a pension. Determine your social security benefits by going to the Social Security Administration website. You can determine the amount of your pension by inquiring from your employer or former employers. If your social security is going to be $1,500 a month and you have a pension that is $1,000 a month, then you need an additional $1,500 a month coming from your assets in order to spend $4,000 a month in retirement.

Working in Retirement

Working in retirement can be considered a backup plan, which I discuss below, but some of you know you need to work in retirement but will want to reduce your hours from what you currently work. If you are going to work part-time and make $500 a month, then in our hypothetical example, you only need $1,000 each month coming from your assets. You can work enough in order to fund the whole $1,500 and let your investments keep growing. At some point you will quit working, so you need to consider that as well.

The 4% Rule

The 4% Rule states that you can withdraw 4% of your assets the first year, index that amount to inflation each subsequent year and have a very high chance of not running out of money over 30 years. You can take the 4% rule further and have a very high probability of never running out of money. This is something to consider if you are planning on retiring very early. An example of this rule is that if you have $1,000,000 in investments, you can withdraw 4%, which is $40,000, the first year. If inflation is 3% that year you withdraw an additional $1,200 in the second year, which would be $41,200.

In our example above where you need $1,500 each month coming from your assets, you need to withdraw $1,500 * 12, which is $18,000 the first year. In order to know how much assets you need, you take that number and multiply it by 25. The inverse of 4% is 25. In our example, that person needs $18,000 the first year, so $18,000 * 25 equals $450,000. That person needs $450,000 in order to have a high probability of never running out of money in retirement. If you’re not going to have a pension or rely on social security and are wanting to spend $80,000 a year, then you need 2 million dollars before you can retire based on the 4% Rule. $2 million X 4% = $80,000.

Other Considerations

You need to consider backup plans. One consideration for a backup plan is, if you are under 40, consider not relying on social security. It may well be available when you’re 65, but I suggest you consider social security as a back-up plan. The more that you can control, the better off you will be.

It’s the same with an employer pension. Although these are not that common anymore, you should still consider a pension as a back-up plan if you have many years before that pension is available to you. If you are under 40, I would suggest you rely on having enough assets saved to rely on the 4% rule. Everything else should be considered backup plans.

Other backup plans are to continue working in some fashion during retirement or reducing your monthly expenses so you can outlast your money. Rental properties are a good way to generate an income, but I wouldn’t consider that 100% passive income. There is work associated with owning rental properties.

The bottom line is, that before you reach the age that you want to retire, you need to sit down with your spouse or by yourself if you’re single and ask yourself, “How much do I need to retire?”. You cannot wait until you’re ready to retire to see if you have enough to retire. The sooner you do this the better off you will be. Don’t go through life assuming that someone else will pay for your retirement years. In the United States of America, we are so blessed that we are in control of how much we want to spend in retirement and saving enough for it. This starts when you are in your 20s. Pay off your student loans as fast as you can, stop using your credit cards, and set goals for building wealth.


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