How Much Money Do I Need to Retire?

Retirement

Feb 29

Okay, let’s get the bad news out of the way first: a one-size-fits-all approach won’t work when you’re trying to calculate how much you’ll need to save for retirement. Feel free to skip this article and research elsewhere if that’s what you’re after, but your efforts will be futile because the answer truly varies based on your income, goals, and lifestyle you want to lead in retirement.

The good news, however? You can take various approaches—including using tools created by financial professionals—to gain additional insight and pinpoint a ballpark number for how much you should aim to save. We’ll explore these methods and much more in this post.

How much retiree households actually spend

Perhaps you’re wondering… Can I live on Social Security alone? or Will a $40,000 annual income work during retirement? The honest answer? It depends. However, you can analyze the latest U.S. Bureau of Labor Statistics Consumer Expenditure Survey for a rough baseline of how much money you’ll need to retire.

The data reveals that annual spending by retiree households—run by someone age 65 or older—averages $57,818 (or $4,818 a month). Over 35% of these expenses are related to housing, which includes mortgage, rent, property tax, and maintenance and repair costs. While paying off your mortgage before retirement can help reduce these expenses, they at least provide a realistic goal regarding the funds you’ll need. Therefore, with all other factors equal, an annual income of $40,000 is perhaps too low a goal as it is approximately 31% less than the average retiree household.

Also keep in mind that these numbers will only increase as time marches on. For example, in 2016, average retiree household spending was $45,756 (or roughly $3,800 a month); the further away you are from retirement, the higher the threshold in this respect.

Retirement rules of thumb

Other approaches can help guide you as well, many of which shine through as rules of thumb. Here are some of the most common:

The 4% rule
While the 4% rule is more of a retirement withdrawal strategy, you can also utilize it to determine how much you need to retire. It states you should take out no more than 4% of your assets in the first year of retirement and then adjust your withdrawals for inflation on an annual basis thereafter. In theory, adhering to this rule will allow your investments to grow in a way that will prevent you from depleting your funds too quickly over a 30-year retirement period.

As for the 4% amount, this is based solely on your investments. Therefore, if you receive other sources of income—such as Social Security or a pension check—you’ll want to exclude that from the withdrawal calculation.

Let’s assume you can live on $50,000 a year and anticipate earning $20,000 from Social Security—with the remainder coming from your investments. As a next step, you’d divide $30,000 by 4% and get $750,000: which is the total amount of money you’ll need in your retirement savings to last 30 years.

The rule of 25
Essentially the same concept as the 4% rule, the rule of 25 works by estimating the annual retirement income you need from your investments and multiplying that number by 25. The result—identical to the 4% rule—will tell you how much money you’d need to save to fund 30 years of retirement. In our example, $30,000 multiplied by 25 equals $750,000.

The 80% rule
As likely the most common method you’ll come across during your research, this rule states that 80% of your pre-retirement income (income upon leaving your job) will be necessary to sustain the same lifestyle after you retire. The thinking here is that some expenses—such as transportation, clothing, and sometimes housing—will decrease during your golden years. Therefore, if you make $100,000 before retirement, you’ll require an annual income of $80,000 to live a comfortable lifestyle after you stop working.

Age-based rule
Fidelity published age-based guidelines as retirement savings benchmarks over a series of years. They state you should have an amount equal to your annual salary saved by age 30, at least six times your starting salary saved by age 60, and so on. While Fidelity admits these goals are aspirational and that you likely won’t reach them, they do serve as a general guideline.

One of the biggest issues with all of these approaches is that they are very simplistic, while planning for retirement is of course extremely complex.

For example, the 4% rule and the rule of 25 are based on a 30-year retirement period. Unfortunately, 30 years is unrealistic for most people as the average life expectancy rate in the U.S.—per the Centers for Disease Control and Prevention—is only 76.4 years.

There is also little, if any, flexibility with these rules. For example, those who rely on the 80% rule may spend a lot more in their early retirement years due to costs associated with traveling and home renovations targeting future needs (e.g., a first-floor bedroom and bathroom). Income requirements may therefore rise above the 80% threshold during these first few years. Alternatively, others may see bear markets that force you to adjust your spending habits to ensure you won’t run out of money sooner than expected.

Retirement calculators

If you’ve used a dedicated calculator to determine how much money you’ll need in retirement, you’re not alone; in fact, over 123,000 monthly “retirement calculator” searches occur on Google according to SpyFu, an online search engine optimization tool.

While these calculators are sometimes useful in determining how much money you’ll need to retire, they do have limitations. For example, online calculators don’t consider variances in your investments (e.g., prolonged downward markets or economic recessions and the amount of time necessary to ride these out). Not incorporating these discrepancies into your calculations can ultimately deplete your money sooner than you expect.

Retirement calculators also vary in sophistication and are based on assumptions that are often wildly incorrect, such as predicting future inflation (an impossible task).

The best approach to calculate how much you should save for retirement

You’ll first want to develop a vision for retirement. More specifically, start reflecting on when and where you want to retire and how you’ll fill up your newfound free time. Although you need to consider several other variables as well (and your plans will likely change over time), this will at least give you a good picture of what your living expenses will look like during retirement.

From there, evaluate where you are now and make any necessary changes—particularly if a gap exists between your current situation and future aspirations. This means saving and investing as much as possible while paying off any debt. Meeting regularly with a financial planner is also often beneficial in this regard, as these professionals can ensure you consistently make the right financial decisions and stay on track throughout your journey.

In sum: how much money you should save for retirement

Calculating how much money you’ll need is one of the most difficult aspects of retirement planning. While useful tools can certainly help guide you in this respect, it’s important to not consider this option a hard-and-fast rule that applies to you with 100% certainty.

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FAQs

Yes, this can significantly impact your financial future over time due to the power of compounding. For example, let's say you’ll reach your desired retirement age in 20 years. By increasing your savings rate by just 10%, you’re setting aside additional funds for investment: potentially boosting your return. If you initially saved $500 per month with an average annual return of 6%, your total savings would amount to $220,714 after 20 years. However, if you decide to save $550 per month instead (a 10% increase), your total savings would amount to $242,785: a difference of $22,071!
First and foremost, don’t feel discouraged; several options are available to help you catch up and better prepare for your future. One potential avenue to explore is catch-up contributions, allowing those aged 50+ to contribute additional funds to retirement accounts and thus potentially boost their savings: bridging the gap between current and ideal circumstances.
Another crucial step to consider is reviewing your asset allocation and risk tolerance. Assessing your investment strategy can help ensure you’re maximizing your potential for growth, and by adjusting your portfolio to match your risk tolerance and pursuing investments offering higher growth potential, you can possibly expedite your retirement savings growth. Read our article on tips for retirement savings procrastinators to explore additional options.
If your income falls between $25,000 and $34,000 ($32,000 and $44,000, if married and filing jointly), you’re required to pay taxes on up to 50% of your Social Security benefits. That number shoots up to 85% if you earn more than $34,000 and are single (or more than $44,000 if you are married and filing jointly).
In addition, some states also levy taxes (to varying degrees) on Social Security income; these include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, and Vermont.
Unfortunately, all but seven states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming—tax your retirement income to varying degrees. Read our article to learn more about states that will cost you more to retire in.