Saturday, December 22, 2012

How Much Money Will You Need to Retire?

**Note: There is a newer version of this post here. **

This post uses the 4% withdrawal approach to calculate savings needed to retire at age 65 for those who earn from $10,000 to $250,000 or more and will be eligible to receive full, or nearly-full, Social Security benefits.

Previous posts established retirement savings benchmarks/targets from age 25 to 65 for a typical average income worker and a typical high-income worker. This post only calculates the target at age 65, and, as a result, is appropriate for all salary levels.

How Much Will You Need to Retire?

Retirement savings needed on retirement date at age 65
How Much Money Will You Need to Retire?

With an Average Salary, You'll Need Around 9 Times Your Salary to Retire

If you follow the 4% withdrawal guidelines, it's easy to calculate how much money you will need in order to retire at age 65. Basically, you will need (100%/4%=) 25 times the amount you expect to withdraw from your savings in your first year of retirement. To facilitate the computation, I have assumed that your total yearly spending in retirement will equal 75% of your current salary, adjusted for inflation.

as you can see from the graph above, at $40,000 -- around the average salary -- the target is only about 9 times your salary, or $360,000 in today's dollars. Why is that? (Note: the 7 times salary calculated in an earlier post is lower because it assumed a 5% withdrawal rate.)

The Effect of Social Security: The Larger Your Salary, the Higher the Multiple You Will Need To Retire

The target for those who will not receive Social Security is 25 times their expenses. Assuming their expenses are 75% of their salary, that target is therefore (25 x 75%=) 18.75 times their salary -- regardless of salary level. The thing that jumps out at you about the graph above (click to expand) is how steep this curve is at the lower salaries, and how flat it is at higher salaries. That's the effect of Social Security.

The percentage of your salary that Social Security will replace decreases as your salary increases. For salaries below $10,000, Social Security benefits are approximately 78% of your qualifying salary. However, that percentage decreases as your salary increases. In fact, under current rules, anyone making over about $115,000 receives the same maximum Social Security payment of about $27,000/year.

The bottom line is that as your salary increases, the amount that will not be replaced by Social Security increases; therefore, the retirement spending that must be funded by your retirement savings increases -- and, the salary multiple increases.

Retirement Savings Needed at $100,000

If you go a little further out on the curve, you can see that those with $100,000 salaries have a target of 12-13 times their ending salary.  The target continues to go up from there. Social Security will replace only 14% of salary for a person making $250,000, and 7% for those earning $500,000. In fact, the more millions you earn, the closer the percentage gets to zero; we should all have such problems....

Manual Method: If You Make More Than $250,000, Less Than $40,000, Have a Pension, Don't Trust Social Security, Or ...

I've "only" extended the graph out to $250,000. If you're lucky enough to be "off the chart," you can easily calculate these benchmark/target savings manually; see the appendix at the end of this post. The manual method is worth checking out even if you're unlucky enough to earn less than $250,000/year.

For example, you may prefer to replace more or less than 75% of your salary based upon your lifestyle.  (I'm especially concerned that 75% may often not be adequate at salary levels below the average.)  Or, you may want to exclude some or all of your scheduled Social Security income -- just to be safe...; the manual method can do that too.

Final note: If I extended the graph out far enough beyond $250,000, the line would get closer and closer to 18.75, the target for those without Social Security.

Some Key Assumptions (short version)

I've assumed that:
  • Your annual raises will keep pace with inflation
  • Inflation-adjusted Social Security benefits remain unchanged; they will increase in line with inflation (this is not likely)
  • You will retire at age 65, and spend 75% of your current annual income (inflation-adjusted) each year of retirement
  • You will follow the "4% Withdrawal" guidelines, starting by withdrawing 4% of your assets your first year in retirement.
For a more detailed discussion of the 4% withdrawal approach and my assumptions, see Assumptions for the 4% Withdrawal Retirement Graphs.

Related Posts

My SIMPLE Retirement Savings Calculator an interactive calculator that does the same calculations used to generate the graphs below. However, he graphs below are better for seeing the big picture.

How Much Should I Have in Savings at my current age to be on target?
What Percent of My Salary Should I Save? by starting age
Social Security Income Estimator : the official site.  For an approximation, see this site, or my graph.
Start Retirement With a 4% Withdrawal Rate A discussion of the 4% withdrawal concept, from Time Magazine. For a more detailed discussion, see Wikipedia.
How Long Will You Live? A look at one of the most vexing issues in retirement planning.
Do You Need a Personal Strategic Plan?: a process for establishing life priorities

Appendix: How Much Money/Savings Does it Take to Retire?

You don't even need a spreadsheet for this! Here's how to calculate how much you'll need.

1. Estimate your total expenses in your first year of retirement, including taxes, in today's dollars (I'm assuming that the first year is representative of all of your remaining retirement years). If you don't have a good feel for what your expenses will be, assume that they will be 70-80% of your salary; for this series, I assumed 75%. Example: $40,000 salary; expecting retirement expenses of $30,000/year.

2. Subtract your expected Social Security income, again in today's dollars, from your expected expenses. (Note: Links to the Social Security estimators are in the section above.  When using these, use the numbers that are in today's dollars and/or specify 0% inflation. If you want to be conservative, you may want to reduce the scheduled amount. ) Example: For a $40,000 salary, Social Security payments are estimated at $15,720/year; therefore, $14,280/year remains to be covered.

3. If you have a pension with a cost of living adjustment, treat it the same as Social Security. That is, subtract your annual pension, in today's dollars,  from the number above. Your annual expenses minus your Social Security, minus your pension payment will tell you how much of your expenses your investments have to cover. Example: No pension, so $14,280/year has to be covered by investments.

4. To use the 4% withdrawal approach, multiply the result from step 3 by 25. That's it. Example: $14,280 x 25 = $357,000 in savings needed at retirement. (If you plan on withdrawing 5%, you would multiply my 20; that result is $285,600.)
My SIMPLE Retirement Savings Calculator will do the above for you if you prefer.

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Copyright © 2012                 Last modified: 12/15/2020

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  1. Thank you for posting this information. One question: How do I calculate how much I'll need if I have a pension that does not include a COLA, or a very limited COLA (3%/year on the first $13000 only)?

    1. The easiest way I can come up with off the top of my head: Estimate the value of your annual pension half-way through your planned retirement, convert that to the equivalent amount in the year that you plan to retire, and assume that is the value that you receive in the first year and all subsequent years. Should at least get you in the ballpark


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