Saturday, December 12, 2020

How Much Money Will You Need to Retire?

This post uses the 4% withdrawal approach to estimate the savings that you will need in order to supplement your Social Security retirement income; the amount needed is expressed as a simple multiple of your salary. In doing so, it assumes that you will retire with full Social Security benefits. Just find your salary on the horizontal/”x” axis, and then look up the savings required on the vertical/”y” axis. For example, at a salary of $50,000/year you would need a bit more than 8 times your salary in order to generate enough income to supplement your Social Security income during a 30-year retirement. 

This post paints the big picture, using some simplifying assumptions. A companion post, my interactive retirement calculator, allows you to tailor the assumptions to arrive at a more individualized estimate of the retirement savings needed (for example, if you do not qualify for Social Security). That post will also help you calculate the yearly savings needed to accumulate the desired amount by your retirement date. (For more on this approach and my assumptions, see later in the post.). 

How Much Will You Need to Retire?

Retirement savings needed on retirement date with full Social Security benefits
How Much Money Will You Need to Retire?

With an Average Salary, You'll Need Over 8 Times Your Ending Salary to Retire Comfortably! 

If you follow the 4% withdrawal guidelines, it's easy to estimate how much money you will need when you retire. 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 ending salary – and that, adjusted for inflation, your ending salary is the same as your current salary. 

However, as you can see from the graph above (click to expand), at $62,500 -- around the average salary in 2020 -- the target is only about 8.5 times your salary. Why isn’t it 25 times salary? For two reasons: a) we are only replacing 75% of the salary, and b) because of the impact of Social Security benefits. 

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

Using the 4% withdrawal strategy, the savings target for those who will not receive Social Security is (100%/4%=) 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 reason the line of the graph is not at 18.75 is because of Social Security. If you will receive Social Security, you will need less than 18.75 times your salary to fund your retirement. 

In the graph notice how steep this curve is at the lower salaries, and how flat it is at higher salaries. The percentage of your salary that Social Security will replace decreases as your salary increases. Whereas Social Security will replace 90% of the salary of the lowest income workers, 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.... 

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 on the graph increases. 

Some Key Assumptions 

The 4% withdrawal approach was developed assuming that you will spend about 30 years in retirement, and that your retirement savings will be in a diversified (stock and bond) portfolio. To simplify the calculations, I've further assumed that:
  • Social Security benefits and your salary will both keep pace with inflation
  • You will retire at the Social Security full retirement age, receive full retirement payments, and have expenses of 75% of your current annual income (inflation-adjusted) in your first year of retirement
  • You will follow the "4% Withdrawal" guidelines, starting by withdrawing 4% of your assets your first year in retirement and increasing with inflation each year thereafter.
  • Your retirement portfolio will earn a real (i.e., after inflation) return of 5%/year

Be aware that, because I have assumed zero inflation, if the chart says that you will need 8 times your salary and that comes out to $400,000 that is $400,000 in current dollars. If your retirement date is, say, 25 years from now and inflation actually averages 3%/year, by then your salary will likely be around $100,000, and 8 times your salary will be $800,000 – which is equivalent to $400,000 in today’s dollars. 

The interactive retirement calculator will let you change those assumptions to better reflect your specific circumstances if needed. It will also estimate the annual savings needed to achieve the desired savings goal. For a more detailed discussion of the 4% withdrawal approach and my assumptions, see Assumptions for the 4% Withdrawal Retirement Graphs.        

Related Posts

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.
Inflation Calculator if you want to translate the required savings from current dollars to the equivalent amount on your retirement date
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

For lists of other posts, by category, see the drop-down list (mobile viewers) or tabs (computer viewers) just below the blog header at the top of the page. There are additional links in the sidebar if your device supports sidebars.
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