One of the most common questions people ask about retirement is how much they should aim to save to ensure a secure retirement. Financial advisors have many different ways to answer this question. If you search online, you will find pages and pages of calculators that will try to answer this question for you.
Some take 75-80% of your income and multiply it by 25. Some just say you need $1 or $2 million. Others ask about your future retirement income. The problem with all of the online sites and calculators is no one ever feels better after using them.
When I lived in Germany, I noticed a subtle difference in the small-talk between people first introduced to each other. Instead of asking what do you do, people asked what do you like to do? The difference those two words make is immense.
We have all sorts of reasons for working at the job we do. People may have been pressured into a particular field by family or teachers. They may have wanted the prestige of a certain job, or the pride of working in a specific field. Whatever their job, chances are they don’t want to do it forever.
But that’s typically not the case with the things we like to do. Retirement calculators ask the wrong question. Instead of asking what we would like to do in the future, we’re asked what we do today. It’s possible to make great money as a rocket scientist, but enjoy spending time hiking and camping. It’s also possible to make around minimum wage but enjoy spending free time taking cruises.
When you use a retirement calculator or follow rules of thumb, all you are told is if you make a lot of money you need a lot of money to retire, and if you don’t make a lot of money, you won’t need as much money to retire. None of this takes into account what you actually want to do once retired. Calculators and rules of thumb aren’t helpful if a Wall Street tycoon wants to retire to rural Iowa, nor if an Iowan waitress wants to retire to New York City.
While I’m not a fan of strict budgeting, I am a fan of budgets in order to know where all of your money is going. If you created a spreadsheet of your spending, it should be easy to find out how much money you would reasonably need in retirement to maintain your current standard of living. Add lines 6 and 10 together to find out how much money you spend today per month. Multiply that by 12, and add in any unexpected money (bonuses, tax refunds, etc.) you receive throughout the year that you don’t invest. Feel free to modify the spreadsheet to remove any expenses you won’t have in retirement, and add any you know you’ll have.
I don’t like to assume I’ll live in a cheaper area when I retire, or a more expensive one for that matter. For my retirement number, I want to know how much money I would need to live my current lifestyle. From the example above, the average expenses were $2,330.62 a month, and the amount of money left over each month averaged $630.63. That’s a total of $2,961.24. The amount of unexpected money is $525 a month. That should have been invested, but whatever that amount, you can treat it as a buffer if you wound up spending it on unexpected expenses. You’re up to a total of $3,486.24 a month or $41,834.92 a year.
The only real number missing from this calculation is healthcare costs, and unfortunately that’s another topic altogether! Much of it will depend on when you retire, and if you can take advantage of Medicare and Medicaid. The highest number I found from an AARP report is $8,834 per year in healthcare spending for those 50-64. That raises your total to $50,668.92.
Entire books can (and have) been written on how much to withdraw from your retirement accounts, and I think 4% is an acceptable figure. Now that you know how much money you want each year, you can determine how much money you’ll need to meet that goal.
I’ve created a spreadsheet that asks you six questions; it’s available here: How much to retire
- How much money do you need per year in retirement (today’s dollars)?
- The average rate of inflation?
- Your average return on investments in retirement?
- Your age today?
- Your age when you retire?
- Your age when you die?
From here the spreadsheet will calculate how much money you’ll need the day you retire to meet your goals.
From our example above, if a 30-year-old wants to retire at age 50, and assumes she’ll need $50,668.92 a year to live her current lifestyle, she would need $2,789,484.68. This is a fun spreadsheet to play around with, or as fun as any spreadsheet can be! Retire at age 55 and expect to depart this world at the age of 95, and the number changes to $2,693,815.03. Select age 67, and that 30-year-old will need $2,747,295.84.
Are you noticing that these numbers aren’t really changing? Why would someone need around the same amount of money to retire at age 55 than at age 67? The reason is because we’re factoring in inflation. If you take inflation out of the picture (make it 0%), the numbers change to $1,088,908.74, $1,003,274.33, and $844,632.68. No one can predict what inflation will be, but you clearly don’t want to exclude it from your calculations. Of course, don’t forget your money is also growing each year you keep investing and postpone retirement, but where’s the fun in that?
By using the spreadsheet provided, you can determine how much money you’ll want to have when you retire. Don’t try to visualize how much money you think you’ll need; base your calculations off of how much money you spent this year or last. Is there any reason to believe your spending in retirement would be dramatically different? If so, make the changes, put the numbers into the spreadsheet, and feel confident that you’ve finally answered the question of how much money you will want to have saved come retirement.
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