Estimating how much you need to retire can feel vague and intimidating because earned income ceases for most retirees.
I took the formula I use with my financial coaching clients and from my How to Retire When You Want program for this post clarifying the formula for estimating how much you need to retire.
In this post, I’ll:
- Step you through the formula for how much you need to retire
- Explain 3 unavoidable factors that can change how much you need to retire
- Share an obvious but overlooked way to significantly lower the amount you need to retire
- Provide my retirement formula video
- Reveal why all retirement planning is imperfect but necessary
Remember, imperfect plans are so much better than no plan.
So let’s get started.
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Factors Affecting How Much You Need to Retire
As an Accredited Financial Counselor, I feel an obligation to briefly address a few crucial factors that can alter the formula for how much you need to retire.
Retirement Formulas Are for Year 1 in Retirement
Retirement formulas calculate how much you need to retire to be able to live in the first year of retirement.
After the first year, the formula needs to be adjusted for inflation. This must be done every subsequent year for retirees to be able to maintain their standard of living in retirement since inflation increases the costs of goods and services.
The More Income the Better
As you’ll see in the math, income plays a huge role in determining how much you need to retire.
Most people don’t realize how much a small income stream outside of retirement savings can reduce the amount needed to retire.
For example, if a retiree makes $1,700 a month in income, it’s like saving approximately half a million dollars more in retirement savings for a retiree planning to make withdrawals of 4% a year!
The truth is many retirees get bored in retirement, and welcome the stimulation and socialization associated with generating income or “work”.
Even introverts can earn part time retirement income online in a number of different ways.
Think outside of Social Security and traditional investment income only.
The Retirement Formula Must Use Estimates
Estimating how much you need to retire must be based on estimates for some pretty crucial factors including:
- How long you’ll live in retirement
- Investment returns
There is simply no way we can know these factors for sure. We can, however, use past data along with a consideration of the current economic environment to estimate investment returns and inflation.
The Formula for How Much You Need to Retire
Notice we’re going to be multiplying and dividing by 12 more than once, which may seem unnecessary. This is based on the way most people track finances which makes it easier to apply the formula to your own situation.
In this example, we’ll assume $10,000 in monthly expenses and $25,000 a year for annual expenses.
1. Total Expenses in Retirement
Here’s the math for our retiree with $10,000 a month in expenses.
Total Monthly Expenses – $10,000/Month
Multiple Expenses of $10,000 by 12 = $120,000/Year
Next, add in Annual Expenses – such as income taxes, property taxes, holiday gifts, and big home or car maintenance items.
$120,000 + $25,000 = $145,000
Then divide Total Expenses of $145,000 by 12 = $12,083
Deduct monthly income from the $12,083– social security, rental properties, side hustles, part time work, etc. Let’s round to $12,000 a month.
$12,000 – $4000 = $ 8,000
The remaining amount, or $8,000, needs to come from retirement accounts.
2. Equate Monthly Expenses to Retirement Withdrawals
Next, decide how much you want to withdraw annually. Withdrawing 4% annually is the most popular percentage for retirement withdrawals based on the 4% Rule.
Please note that I am NOT suggesting a 4% retirement withdrawal; the safe withdrawal amount depends mostly on the investment return you’ll get during retirement and other variables.
We will use 4% in this example since most financial advisors and retirement plans use 4% when estimating how much you need to retire.
3. Get Your Retirement Number
Here’s the final math.
$8,000 x 12 Months = $96,000/Withdrawal Percentage of 4% = $2,400,000
This retiree needs over two million dollars to retire based on the retirement formula.
The Retirement Formula Summary
As you can see, the formula for how much you need to retire must include numbers based on unknown factors. That’s why I always emphasize that this formula provides an estimate making it imperfect but very useful.
The truth is we can’t establish goals for retirement savings without an estimate of how much we need to retire. This formula lays the foundation that guides investors to:
- Spend smartly
- Invest as much as possible
- Invest as good as possible
Plans are just that; they are plans. Plans get modified when needed but they inspire us toward our financial goals and call us to action along the way.
You can watch my video outlining the formula for how much you need to retire with additional tips.