For someone in his or her 20s, 30s or even 40s, it is difficult to really ask this question. Retirement seems so distant. Our society has gotten used to short term planning and neglected to consider the steps after. If I ask what age you are expecting to retire at your current saving rate or how much money you need to save to retire and be financially secure to support you until your death, many of you may shrug your shoulders. You wouldn’t be the only one.
A 2015 Government Accountability Office (an agency of the U.S. government that monitors and audits government spending and operations) study found that
- 55 to 64-year-olds have an average of $104,000 in savings
- 65 to 74 have $148,000 in savings
If these individuals were to retire today, they would only have $310 and $649 respectively per month for the rest of their lives. It does not take much calculation to realize this is not enough money to retire. So how much do you need to retire?
To figure that out you need to know how much money you spend. Once you know how much you spend per year, you can calculate how much you need to retire using the rule of 4%. This rule states that withdrawing no more than 4% of your total savings a year will allow your nest egg to last the rest of your life (a more elaborate explanation to come in future blogs). Conversely, multiplying your yearly spending by 25 (i.e. the inverse of 4%), will give you the amount that you’ll need at the beginning of your retirement. For example, if you figure out that you spend roughly $40,000 a year, 40k multiplied by 25 is one million, which is roughly the amount you will need to retire. Do you have one million dollars in your retirement accounts? How much do you spend a year now?
Here are a few other items worth considerations:
- You’ll likely spend less in retirement than you do while you’re working. . If you are in your 40s and 50s considering your retirement plans, it may be terrifying to realize that you will never save enough to retire at your current saving rate vs. spending rate. Don’t despair. Remember you will have fewer expenses in retirement. Your kids will likely have finished college and have hopefully became financially independent. Your taxable income will drastically decrease once you retire which will likely bump you down a bracket or two. You will likely have paid off your house.
- A Roth account can help to decrease your tax burden. Withdrawing from your Roth account is tax free. It means you will need to withdraw less from your tax deferred account, like 401k or traditional IRA, which results in less taxable income each year during retirement, i.e. you will be paying even less tax. (I know that there’s a lot of jargon in this one, I’ll elaborate in a future article.)
- You should add social security to your calculation. Many people fear social security will go away by the time they retire. Is it possible? Yes. Should you be worried about it? Probably not. Social security taxes everyone and serves everyone. It is career suicide for any politician to try to defund social security or even fail to find a budget for social security. I simply don’t see it dissolving.
- You may have other sources of income. It’s difficult for a lot people to go from a full time job to no job. There is a sudden lack of purpose in retirement. Why not rent out that old house or cabin on the lake you own? Short term lease or long term rental, it provides a steady stream of cash during retirement. And its maintenance will provide plenty of purpose and sense of accomplishment in retirement.
- You can find other creative ways to make your nest egg last. Moving to a cheaper area is a great way to extend retirement savings. What about moving to a state with no state income tax? (Washington or Texas for example are great places to retire to further reduce tax burden during retirement.) Retire in a foreign country? Absolutely! Cost of living in the US is astronomical compared to many countries around the world. Your savings will last you twice as long if you cut your yearly expenses in half. Not to mention that you’ll get to explore the world!
What do you guys think about using the 4% rule in rough estimation of retirement need? Any other tricks to make your nest egg last longer in retirement?
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A few years ago, I set a goal to read one financial book a year to teach myself a critical set of skills that I didn’t learn in school. I think everyone should do it. I recommend starting with this book. I’ve read it cover to cover three times now. Learning new things every time.
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