Eight Steps to Calculate How Much You Need to Retire
Written by: Kristy Welsh
Last Updated: December 26, 2020
It is estimated that fewer than half of all Americans have ever tried to determine how much money they will need in the bank in order to retire comfortably. With the public and private pension systems in trouble, and Social Security benefits not being able to keep up with inflation, saving for retirement is your business alone. You will need to figure out how much you will need in your retirement fund and how to get to this amount.
The question of how much you need to retire may have a simple answer, but it is not the same for everyone. That's why any blanket statement for how much you need to retire should be taken with a grain of salt. It all depends on your living expenses now and how you expect them to change (or not) by retirement age.
There is an array of online retirement calculators that can help you sort this out, but instead of blindly trusting the results, you are best-served having a basic understanding of all that should be factored in so that you can make mindful financial decisions accordingly. The top key considerations are:
- Life Expectancy: The Society of Actuaries estimates that for a married 65-year-old couple, there is a 45 percent chance of one person reaching 90 and a 20 percent chance one will reach 95. Plan for a long life.
- Medical Costs: EBRI estimates that a 65-year-old couple in 2019 that does not have any employer-provided health benefits will need $450,000 to have a 50 percent chance of funding health care expenses not covered by Medicare. Even with employer benefits, there is a 50 percent chance that out-of-pocket expenses will reach $268,000.
- Inflation: Over 30 years, expect inflation to cut your spending power in half. You would need nearly $12,000 today to match the spending power of $5,000 in 1982.
- Investment Style: You may never reach your number if you hide from stocks. Bond yields and short-term interest rates are so low that, adjusted for inflation, you may get little or no growth for years.
- Savings Rate: A good rule of thumb is saving 15 percent of income each year throughout your working life.
Eight Easy Steps to Calculate How Much You Will Need to Retire
- Assume you will need just as much per year as you are living on now. Yes, conventional wisdom holds you will need 70 to 80 percent of your income in your retirement years. However, most people grossly underestimate how much they need for retirement. Even though there are expenses you can expect to fall off by retirement age (see Step 2), other expenses will inevitably materialize to balance things out.
- Subtract from your current annual living expenses those costs that you know will drop off by retirement age. These expenses may include:
- Retirement savings
- Mortgage payments
- College tuition
- Student loans
- Credit card debt
- Add in any costs for health care you expect to incur at retirement age, such as long-term care insurance.
- Adjust your annual retirement-age living expenses for inflation, at 3.5 percent per year.
- Subtract from your annual retirement-age living expenses (adjusted for inflation), the amount you expect to receive from social security and your pension (if applicable).
- Whatever the difference — after subtracting social security and pension — is how much you will personally need to cover via your retirement savings plan.
- Determine your life expectancy based on your family history and personal health. Then multiply the number of years you expect to live in retirement by the annual amount of money you are personally responsible for covering. For instance, if you retire at 65 and expect to live to be 95, you need to save enough money to cover 30 years of retirement. If, after all of your calculations, you determine your retirement-age living expenses are $50,000 a year, but your social security and pension cover $20,000 of that, then your savings plan must provide for $30,000 a year. This means you need to have $900,000 in savings by the time you are 65. Note: A quick and easy way to determine your needed retirement savings is the “multiply by 25 to withdraw 4%” rule. Once you determine your needed funds each year, multiply by 25. Each year, you can withdraw 4% of your funds without running out of money.
- Considering your age now, figure out how much you need to set aside per year — between now and 65 — in order for you to meet that goal. Then divide that number by 12 to determine how much you should be depositing each month into your retirement savings account.
Whatever you do, don't let the enormity of your retirement savings goal overwhelm or discourage you. If the amount you "should" be saving is not practical or possible, then simply do your best. What's more important is that you save consistently and aggressively from this point forward. Find more information on budgeting and saving your money here.