En español | Figuring out how much money you need to retire is like one of those word problems from high school that still haunts you. “If X equals your spending in retirement, Y equals your rate of return and Z equals the number of years you will live, how much will you need to save, given that X, Y and Z are all unknowable?"
The retirement equation isn't unsolvable, but it's not a precise calculation, either. You'll need to revisit your retirement formula once or twice a year to make sure it's on track, and be prepared to make adjustments if it isn't. Weigh these four factors to get a better handle on how much money you will need to retire.
Factor No. 1: How much will you spend?
The rule of thumb is that to you'll need about 80 percent of your pre-retirement income to maintain your lifestyle in retirement, although that rule requires a pretty flexible thumb.
Why not 100 percent? For one thing, you will no longer be paying payroll taxes toward Social Security (although you may have to pay some taxes on your Social Security benefits), and you won't be shoveling money into your 401(k) or other savings plan. In addition, you'll save on the usual costs of going to work, such as new clothes, commuting, lunches and the like.
In determining how to cover that 80 percent, you need to factor in retirement account withdrawals and any other income you expect to receive, such as Social Security, a pension or an annuity. If your annual pre-retirement income is $50,000, for example, you'll want those income streams to add up to at least $40,000.
Say you and your spouse have checked your Social Security statements and can expect to receive a combined $2,000 a month in benefits, or $24,000 a year. You’ll need about $16,000 a year from other sources. Bear in mind that any withdrawals from a tax-deferred savings account, such as a traditional IRA or a 401(k) plan, would be reduced by the amount of taxes you pay.
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Next, consider the things you might want to spend money on. “In the first three years of retirement, the biggest expense is often travel,” says Mark Bass, a financial planner in Lubbock, Texas. New retirees “want to take a four-week trip somewhere, maybe pay business class to get there, and it can cost $20,000 or so.”
That's not a problem, Bass says, as long as you build it into your budget and the trip doesn't end in the poorhouse. So, you’ll want to develop a retirement spending plan alongside your income projection.
Medical care is another expense to factor in. For 2024, the standard monthly premium for Medicare Part B, which covers most doctors’ services, is $174.70 or higher, depending on your income. You also have to pay 20 percent of the Medicare-approved amount for most medical services as well as a $240 annual deductible. All told, the average couple will need $315,000 after taxes to cover medical expenses over the course of their retirement, excluding long-term care, according to estimates from Fidelity Investments.
Finally, there's the question of how much, if anything, you wish to leave to your children or charity. Some people want to leave their entire savings to their children or the church of their choice — which is fine, but it requires a much higher savings rate than a plan that simply aims to have your money to last as long as you do.
Factor No. 2: How much will you earn on your savings?
No one knows what stocks, bonds or bank certificates of deposit will earn in the next 20 years or so. We can look at long-term historical returns to get some ideas.
According to Morningstar Direct, stocks have earned 10.13 percent a year on average since 1927 — a period that includes the Great Depression as well as the Great Recession. Bonds have earned an average 4.94 percent a year over the same time. Treasury bills, a proxy for what you might get from a bank deposit, have returned 3.25 percent a year. Annual inflation has averaged about 3 percent over that period, Morningstar says.
Most people don't keep 100 percent of their retirement savings in a single type of investment, however. While they might have part of their portfolio in stocks for growth of capital, they often have part in bonds to cushion the inevitable declines in stocks. According to Vanguard, a mix of 60 percent stocks and 40 percent bonds has returned an average of 8.8 percent a year since 1926.
Financial advisers often recommend caution when estimating portfolio returns. Gary Schatsky, a New York financial planner, aims at 2.5 percent returns after inflation, which would be about 5.5 percent today. That may seem modest, he says, but it's probably better to aim too low and be wrong than to err aiming too high.
Factor No. 3: How long will you live?
Since no one really knows the answer to that question, it's best to look at averages. At 65, the average American man can expect to live 18.8 more years, to nearly 84, according to U.S. Census data. The average 65-year-old woman can expect to live past her 86th birthday.
"Most people err on the shorter side of the estimate,” says Schatsky. That can be a big misjudgment: If you plan your retirement based on living to 80, your 81st birthday might not be as festive as you'd like.
It makes sense to think about how long your parents and grandparents lived when you try to estimate how long you'll need your money. “If you're married and both sets of parents lived into their late 90s, the only way you're not getting there is if don't look both ways when you cross the street,” Bass, the Texas financial planner, says.
Even if you don't have quite that level of confidence, if you’re in good health and there’s a family history of longevity, it’s best to build a financial plan that can provide for you for at least 25 years of retirement.
Factor No. 4: How much can you withdraw from savings each year?
A landmark 1998 study from Trinity College in Texas tried to find the most sustainable withdrawal rate from retirement savings accounts over various time periods. The study found that an investor with a portfolio of 50 percent stocks and 50 percent bonds could withdraw 4 percent of the portfolio in the first year and adjust the withdrawal amount by the rate of inflation each subsequent year with little danger of running out of money before dying.
For example, if you have $250,000 in savings, you could withdraw $10,000 in the first year and adjust that amount upward for inflation each year for the next 30 years. Higher withdrawal rates starting above 7 percent annually greatly increased the odds that the portfolio would run out of money within 30 years.
More recent analyses of the 4 percent rule have suggested that you can improve on the Trinity results with a few simple adjustments — not withdrawing money from your stock fund in a bear-market year, for example, or foregoing inflation “raises” for several years at a time. At least at first, however, it's best to be as conservative as possible in withdrawals from your savings, if you can, to reduce the risk of outliving your money.
The 4 percent rule is very conservative for most people, and requires a fair amount of money to generate adequate income: A $1 million retirement nest egg would generate $40,000 a year in income. For many people, working a bit longer will help close the savings gap. Not only will you continue to bring in a paycheck, but you'll be better able to delay claiming Social Security benefits and reap bigger monthly payments.
“It's a serious decision when you decide to retire, because you can't turn the [income] spigot back on,” says Schatsky. “Every day you work gives you the ability to increase your retirement enjoyment later."