Are you dreaming of the day when you can ditch the ole 9-5 for something more rewarding?
Many dream of the day they can retire. Motivations may be different but the end goal is the same: Only work because I want to, not because I have to.
Warning: In my opinion, there is no replacement for having a financial plan put together with the help of a fee-only financial planner.
With that said, my goal for this post is to help those of you that may try to navigate retirement planning on your own. I want to at least guide you and share with you a simplified calculation that may help answer the question: When can I retire?
Retirement Factors To Consider
When planning for retirement, there are numerous factors involved. Many of which will certainly change over the course of the next few decades. A short list that immediately come to mind include:
– How Much You Have Saved
– Investment Allocations
– Investment Returns
– Income Tax Rates
– Social Security Benefits
– Health Care Expenses
– Life Expectancy
– Cost of Living (example: NYC is more expensive than Omaha, NE)
Navigating all of these topics can be complex, which is why I suggest utilizing the expertise of a financial planner. But, enough with that. On with answering the question!
How Much Income Do I Need?
One rule of thumb to determine how much income you will need to maintain your current lifestyle in retirement is to use 70-80% of your current income.
Example: Pretend your current income is $100,000. You could estimate you need about $75,000 per year to maintain your current lifestyle in retirement ($100,000 x 0.75 = $75,000). The reason for needing less than 100% of your current income is that you will no longer be paying FICA taxes or saving for retirement.
The downside with using a percentage of your income is that it is based on your income instead of what really matters: your spending.
Instead Ask: What Are My Expenses?
Some families save large percentages of their salary while others (with the same income) may struggle from month to month.
The truth is your lifestyle and your financial choices (whether a minimalist or not) greatly impact your ability to retire.
The amount needed to fund the basic needs of one minimalist family could be completely different than another.
How big of a house do you “need”? How new of a car do you “need”? Is dining out or wearing name brand clothes important to you?
As we walk through this caluclation, remember, it’s the expenses (not necessarily your income) that dictate how much money you need to save to retire.
As mentioned before, this is a simplified calculation but it can help you come up with your own conclusions on when you can retire.
I’ve split this simple calculation into four steps:
1. Calculate Yearly Expenses
The first number you need to calculate is your current spending. Eventually we’ll want a number for yearly expenses.
You may find it easier to calculate your monthly expenses and multiply it by 12 to land at your yearly estimate. It’s a little dangerous to do it this way because every month is different, but for the sake of simplicity it’s a good place to start.
We will use this figure as the basis for your desired income in retirement. There’s no need to include current expenses that will go away when you retire like college savings.
2. Estimate Future Payments From Social Security and/or A Pension
The second number you need to calculate is to estimate your future sources of retirement income (not including income from your investments).
We’re talking about your Social Security benefits or future payments from a pension plan. The closer you are to retirement the easier and more accurate these estimates will be.
3. Subtract Expenses From Social Security
Subtract your future Social Security income and pension plan income (Step 2) from your annual spending (Step 1). This will result in the amount of income you will need to supplement using your investments.
A small adjustment for income taxes may be needed. Many retirees fall in lower tax brackets, so don’t get too complicated with this piece of the equation. Remember, this is a simplified calculation.
Let’s take a look at an example.
1. Ben calculates that he has about $56,000 in yearly expenses.
2. Based on the figures of his Social Security statements, he estimates approximately $16,000 worth of annual benefit payments.
3. This means that Ben has an approximate $40,000 shortfall per year.
In this example, Ben will need to withdraw $40,000 from his savings each year to maintain his standard of living.
4. The Final Step
The final step is to determine how much total savings is needed to fund the shortfall each year.
One rule of thumb states you can safely withdrawal 4% per year from your retirement portfolio. (The 4% withdrawal rate is actually a conservative estimate based on a study that analyzed 30 years of market returns. A withdrawal rate was chosen that would work in the worst scenario in history.)
To find the lump sum savings you need to have in place, divide your annual shortfall amount by 4% (or 0.04). For example, if your annual spending, minus projected Social Security and pension benefits, is a $30,000 shortfall, then you would need investment assets of $750,000 ($30,000/0.04 = $750,000).
Likewise if we continue with Ben’s example above and have a $40,000 shortfall you would need investment assets of around $1,000,000 ($40,000/0.04 = $1,000,000)
Once you figure out the investment assets you need to have in place, subtract from that figure what you actually have saved.
Ben has $950,000 already saved and plans to knock out that remaining $50,000 over the next two years, after which he plans to retire!
Once again, there are many factors at play that impact your results like having your investments properly invested for your tolerance of risk. So be careful and conservative with your estimates!
How close are you?
How does your number make you feel? Are you nearing the time when you can call it quits on the 9-5 or do you need to kick your retirement savings into overdrive?