The best way to identify the dollar amount you’ll need to save to retire the way you want is to estimate how much you intend to spend every year.
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“You’ve probably heard figures like $50,000, $75,000, or even $100,000 tossed around,” said entrepreneur and investor Tim Schmidt, vice president of business development at Cayman Financial Review. “These aren’t just random numbers. They’re what many financial gurus believe could give you a comfortable year, though it can vary based on where you live and how you like to spend.”
If you’re among the many people who aspire to one of those three commonly cited annual spending estimates, here’s how much you’ll need to make your retirement dreams come true.
The standard rule of thumb for gauging the savings needed to support a given yearly expenditure assumes identical annual withdrawals adjusted for inflation.
“A common guideline for determining how much you need to save is called the 4% rule,” said estate planning attorney Celeste Robertson, owner of the Law Office of Celeste Robertson. “This rule suggests that if you withdraw 4% of your savings annually, your money should last for 30 years, assuming a diversified investment portfolio. According to this rule, you’d need a nest egg of $1.25 million for a $50,000 annual retirement income. To generate $75,000 per year in retirement, you would need retirement savings of $1.875 million using the 4% rule. For a $100,000 annual retirement income, the 4% rule would suggest a nest egg of $2.5 million.”
If you’re aiming for 50 grand, remember, Social Security gets you almost halfway there.
“Assuming a retiree receives the average Social Security benefit of $21,380 annually, $28,620 will need to come from making retirement account withdrawals in order to spend $50,000 a year,” said Camille Gaines, accredited financial counselor and founder of Retire Certain. “Dividing $28,620 by the most popular withdrawal rate of 4% reveals that $715,511 will be needed in retirement savings to fund $50,000 of spending in this situation.”
That’s a whole lot more attainable than $1.25 million — but remember, a dollar buys more today than it will in five years.
“Importantly, $50,000 will need to be increased annually to maintain purchasing power due to inflation,” Gaines said. “The inflation factor will increase the amount of savings needed to support the same lifestyle.”
So, how about those who aspire to a six-figure lifestyle?
“A person will need $2.5 million in retirement savings to spend $100,000 a year based on the commonly used 4% withdrawal rate,” Gaines said. “The amount of retirement savings needed will be reduced to $1,965,500 assuming the average Social Security benefit of $21,380 is received annually.”
The previous examples offer broad guidelines that paint a general picture of what retirees will likely need to cover their annual expenditures — but they omit important financial minutiae that can change the equation.
“To determine a savings amount needed to support a specific amount of annual spending, the following factors — at a minimum — need to be considered,” said Drew Parker, creator of The Complete Retirement Planner (TCRP), a tool for building individualized financial plans for both pre- and post-retirement.
Parker outlined the following considerations:
- Taxes, like federal taxes on income — including Social Security — savings interest and capital gains, as well as state taxes, which range from 0% to 13%
- Expected investment returns
- Income from Social Security, pensions, dividends, annuities, etc.
To determine the savings needed for a couple to spend $50,000, $75,000 and $100,000 annually, plus federal taxes, for 25 years until age 90, Parker assumed the following:
- Both are currently 65
- Both would claim Social Security at age 67
- One person would receive a $2,000 monthly benefit — a little above average — and the other would receive a spousal benefit only
- An annual Social Security cost of living adjustment (COLA) of 1.6% (the five-year average between 2017 and 2022)
- An annual inflation rate of 2.5% (the 20-year historical average)
- An annual return on investments of 5% (mid-range between conservative and optimistic)
Here’s what that couple would need to save in today’s dollars to achieve all three income tiers for 25 years:
- $50,000: $365,000
- $75,000: $975,000
- $100,000: $1,550,000
“In each case, annual savings withdrawal rates begin at a little over 4% and would increase each year until age 90 since savings would decrease and expenses would increase each year,” Parker said. “There is no need to maintain a specific annual withdrawal rate unless your goal is to maintain a specific savings balance at age 90.”
The 4% rule is probably the most common formula, but it’s hardly the only — or even the most straightforward — route to identifying your annual spending-based savings target.
“Another approach to calculating the right nest egg number is the 25x rule,” said Scott Allen, licensed agent. “This rule suggests that you need to save 25 times your annual expenses if you want to achieve financial independence. For example, if your annual expenses are $50,000 then you will need to have a nest egg of $1.25 million in order to achieve financial independence. For $75,000 and $100,000, it would be $1.875 million and $2.5 million, respectively — all three precisely match Robertson’s figures using the 4% rule.
John Grace, financial advisor and founder of Investor’s Advantage Corporation, thinks even farther outside the box with a unique approach to retirement planning, which he calls the bucket strategy.
“It involves dividing your retirement savings into different buckets, each with a specific purpose and time horizon,” Grace said. “For example, you might have a short-term bucket with cash or cash equivalents to cover one to two years of living expenses, a mid-term bucket invested in bonds or conservative investments to cover the next five to 10 years, and a long-term bucket invested in stocks for growth over the long haul. This strategy can help retirees manage market volatility, reduce the need to sell investments during market downturns, and provide peace of mind about covering expenses in different time frames.”
The 4% and 25x rules are based on building savings and drawing the same percentage or amount from it every year. The problem with that is an overreliance on a singular source of wealth to cover your predetermined annual spending.
“There are many different paths one can take to reduce the amount of savings needed to support retirement spending besides making only account withdrawals,” Gaines said. “Income streams from other sources can dramatically reduce the amount of retirement savings needed. Such income can come from a multitude of options such as owning real estate rental properties, private lending, selling covered calls, outsourcing skills, or part-time employment.”
The most important things are flexibility and the ability to adapt through diversification.
“Life throws curveballs, like unexpected health issues or those surprise events that just pop up,” Schmidt said. “Plus, let’s not forget the unpredictability of markets. During the 2008 crash, while many of my real estate investments were having a hard time, my investments in things like gold came to the rescue. That’s why I’m all about mixing it up — a little bit in traditional stocks, some in real estate, a sprinkle in precious metals, and for those feeling a bit bold, maybe even a dab in cryptocurrencies. While every investment carries its risks, diversifying can give you a safety net.”
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