The financial advisors say you need 80% of your pre-retirement income, $1 million or 12 times your pre-retirement income. How much do you really need to retire comfortably?
Conventional Wisdom
80% of Your Pre-Retirement Income
The rationale behind this is that after you retire, you will not need to contribute to your retirement account, pay social security or Medicare taxes. Certain work related expenses such as eating out, commuting cost, clothes, and parking will also decrease or disappear. Depending on how much you were spending on these items, you can probably live on less than 80% of your pre-retirement income.
$1 Million to $1.5 Million
The second common advice on how much you need for retirement is somewhere near $1 million-$1.5 million. This is based on the 4% rule, which assumes that you can safely withdraw 4% without running out of money. Traditionally, the stock market has returned an average of 7-10%. Assuming 3% for inflation, you can withdraw 4% without dwindling down the principle. If you have $1 million in retirement savings, you can safely withdraw 4%, which is $3,333 per month or $5,000 for $1.5 million.
12 Times Your Pre-Retirement Salary
The third common advise on how much you need for retirement is that you need 12 times your pre-retirement salary. The median income of American is $61,937. Based on this income, according to Ally.com, an ideal savings goal by age is the following:
age | income | dollars |
30 | 1 X your income | $61,937 |
40 | 3 X your income | $185,811 |
50 | 5 X your income | $309,685 |
60 | 7 X your income | $433,559 |
70 | 9 X your income | $557,433 |
80 | 11 X your income | $681,307 |
Average Versus Median
In reality, what an average person has in their retirement plan is far from what the experts are recommending. According to Vanguard’s analysis of over 5 million 401(k) plans, the average balance was $92,148 with a median of $22,217.
Median is a better representation of the middle since high earners will skew the average.
Better Way to Find How Much You Need to Retire
First Step: Calculate Your Annual Expense
An ideal way to solve a problem is learning all the conventional methods then find a solution that works best for you. I found that the most helpful way to figure out how much you need to retire is to first calculate your monthly expense.
Make sure you add in annual expenses such as property taxes, capital costs, and holiday spending. Also add the costs of hobbies, travel, health insurance, and long term care.
On the other hand, without a job you will not be able to contribute to 401(k) or Roth IRA since the contributions are based on earned income.
Other Factors that Affect Your Expense
Mortgage or rent: Making a plan on how to pay off your mortgage will help if you’re on the low end of savings.
Marital status: Couples generally have a higher median total of $52,116 versus $23,064 for unmarried men and $19,764 for unmarried women (National Institute on Retirement Security).
Average Expense
According to the Bureau of Labor Statistics data, older households (65 or older) spend roughly $3,800 per month or $45,000 per year. An alternative to figuring out how much you need to retire is to use this number as a guideline.
Second Step: Apply the Rule of 25
Now multiply your anticipated annual expense by 25. The idea is that you’ll be able to safely withdraw 4% from this sum. The stock market returned an average of 10% a year.
For example, in order to generate $40,000 per year, you’ll need to save $1million.
Prepare to Retire in Your 50's
While only 6% Americans think they’ll retire when they are in their 50’s, the number is actually higher. Due to job burn out, physical ailment and other reasons, 29% Americans retire in their 50’s. The more you save, the earlier you can retire.
Now that you know how much you need to retire, follow my next post to find out how to generate the income that you need.