How Much Do We Need for a Comfortable Retirement?

How much do people facing retirement need to live comfortably once they’re there? Fortunately, there are several ways to calculate how much you’ll need, and they all center around how much you will likely be spending and how long your retirement will be.

The amount needed for a comfortable retirement has moved to the foreground of public conversation as more and more people are funding their retirement through tax-advantaged savings plans such as 401(k)s and Individual Retirement Accounts (IRAs) rather than relying on pensions. It’s common to hear figures like $1 million, particularly in headlines.

But in fact, there is no one magic number. It depends upon your individual plans and your expected longevity. Let’s look at how to calculate the figures you’ll need for a comfortable retirement.

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Calculate your expected retirement budget

First, you need to calculate how much you’ll likely be spending in retirement. There are two possible methods. One is to estimate that you’ll spend some percentage of your pre-retirement costs in retirement.  You may read figures like from 70 percent to 80 percent of your pre-retirement costs in retirement. Many of our clients desire 100% or more of their pre-retirement costs as they fully enjoy their retirement years and the efforts of their hard work.  The other is to calculate your estimated retirement expenditures in all categories. As many people already have a budget in place, this simply involves revising it for retirement expectations and is likely a more accurate approach to your individual spending needs.

Your expenditure forecast depends very much on what your plans are for retirement. Some people may plan to downsize and move to a less expensive area. If so, your real estate costs could be much less than they were pre-retirement. They will also be much less if your current mortgage will be paid off.

But other expenses may arise in retirement. If you want to travel extensively in retirement, for example, your travel budget could be much more than it was before retirement. Health care costs can be very high for older people, for several reasons. First, many people develop health conditions in old age. Second, health care costs have been subject to steeply climbing inflation, and that will likely continue. The average older American currently spends $5,766 in health care costs per year.

In addition, of course, health care costs are not the only category where prices rise over time. It’s prudent to assume that inflation will erode your purchasing power in all categories by about 3 percent annually. Be sure to factor that into your forecast of retirement expenditures.

Figure out any expected income in retirement

Next, figure out any expected income you can expect in retirement, either from Social Security or other sources, such as pensions.

The Social Security Administration compiles an annual record of your income if you qualify for Social Security. You can calculate your expected benefits at retirement here.

While Social Security is a crucial part of the income for many older people, it can’t be relied on solely for a comfortable retirement. The average Social Security benefit for retirees was just over $1,430 in 2019. It is prudent to consider it as one strand of your retirement income and to know what it is likely to be.

The same is true for any other expected income like pensions. If you are eligible for a pension, check with your pension plan administrator to see what the amount at retirement is forecast to be.

Determine the savings you will need for a comfortable retirement

Ah, so what will the other strands of your retirement income be? They are very likely to consist of your retirement savings, in vehicles like 401(k)s and IRAs, and other investment savings.

How much do you need to save for a comfortable retirement? One popular method is to use the rule of 25. You calculate how much you will need each year in retirement (subtracting any expected income like Social Security), and then multiply the remaining figure by 25. 

In other words, if you need $40,000 each year in retirement in addition to your other guaranteed income streams, you’d need $40,000 multiplied by 25 in your savings when you retire, or $1 million. (That’s where the popular $1 million in retirement comes from!) If you need $60,000, you need to save $1.5 million.

Don’t be daunted if this seems like a large figure. A great deal of it comes from expected appreciation in your retirement and investment portfolios. A 30-year-old who begins saving $613 every month will reach $1 million by the age of 67, assuming an average annual appreciation of 6 percent. (Remember, too, that many employers match 401(k) contributions by some percentage, which makes the monthly figure easier to obtain.)

Know how much you can comfortably withdraw each year

Now, on to your yearly withdrawals in retirement! Say you have saved a nest egg of $1 million for retirement on the assumption it will let you withdraw $40,000 each year. How do you know you can withdraw that $40,000 each year and not run out? In other words, how can you allay any anxiety about running out of money in your golden years?

One approach is the 4 percent "rule of thumb". The 4 percent "rule of thumb" is often used in conjunction with the rule of 25. You can withdraw 4 percent of your nest egg each year, says the 4 percent "rule of thumb", without running out for a period of 30 years. 

In other words, if you retire at the age of 66 with $1 million in retirement savings, you can withdraw 4 percent of it, or $40,000, each year for the next 30 years, until you are 96. 

While the rule of 25 and 4 percent "rule of thumb" are useful general approaches, given the importance of retirement planning and ensuring that you will have a comfortable retirement without concerns for money, we believe that utilizing a more comprehensive approach with the development of a comprehensive financial plan including detailed retirement modeling using Monte Carlo simulation is the most prudent way to develop and confirm your retirement plans.  Once this detailed planning is completed, the rule of 25 and 4 percent "rule of thumb" are excellent ways to reaffirm the plan that you have.

Assess your expected longevity

For many people, the 30-year period covered under the 4 percent "rule of thumb" is sufficient to allay any anxiety about running out of money. Life expectancy, on average, is currently in the mid-80s (84 for men and over 86 for women).

But life expectancy has also been broadly on the rise over the last century. When Social Security was first instituted in the 1930s, for example, the average life expectancy was more than 20 years less than it is now. Currently, if an upper-middle-class couple is both 65 today and healthy, there is a 43 percent chance that either one or both will live until the age of 95. 

In other words, It is possible that you will live longer than the averages indicate, especially if you have a family history of longevity. If you think this is likely, your savings plan and portfolio can be adjusted so that your withdrawals will last through your expected lifespan. 

We hope that this has helped explain the basics of budgeting, planning, and investing for your retirement. At Financial Freedom Fee-Only Wealth Management we are passionate about helping our clients achieve and maintain financial independence. Contact us today for a complimentary consultation to see if we’re the right fit for your needs.