How Do You Know How Much Money You’ll Need to Retire?

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Do you feel lost when it comes to knowing how much money you should be saving for retirement?

If you are, don’t worry … you’re not alone. As it turns out, an astonishingly high number of us are confused when it comes to retirement planning. According to a Bankrate survey, 61 percent of Americans don’t know how much money they’ll need to save for retirement, including nearly three-fifths of every adult generation over age 37.

While that number is very high, its not surprising at all. Ever since most U.S. businesses made the shift from pension-based retirement plans to 401ks, 403bs, and 457bs, both the burden of saving as well as the knowledge and insight of knowing “how much to save” has been placed squarely on the shoulders of you, the employee.

So how can you figure this out on your own? How does someone know exactly how much money they’ll need to live happily ever after and never have to return to work again?

Contrary to what most financial advisors would tell you, defining how much money you’ll need for retirement is not nearly as complicated as it needs to be. Really all you need to do is just put some thought into a reasonable estimate (which is all the paid experts would be doing for you too).

The great thing about estimates – they don’t have to be exact. They just have to be close enough to give you a sensible target to shoot for. And that’s exactly what we’re going to do here. In this article, I’ll show you how you can determine for yourself what kind of retirement you’d like to have, how much it will cost, and if it will be possible to achieve.

Imagine What You Want Your Retirement to Be Like

Forget all the numbers and spreadsheets for a minute. The first step of planning your retirement is self-reflection. Simply take a minute to imagine what you want your retirement to be like.

Close your eyes and what do you see?

Will you and your spouse finally travel the world and go to all of the places you’ve always wanted to visit?
Will you finally start that business you’ve always wanted to start?
Will you volunteer your time and expertise giving back to the community you love?
Will you take on some sort of passion project like writing a book or starting a service that helps the less fortunate?
Will you live pretty much the same as you are right now?

Quite frankly, it doesn’t matter what you choose or want to do with your time. It's your life! The important thing is setting a direction and then determining how you get there.

Why start like this? Because all too often we do retirement planning in reverse. We figure out how much we can save and then try to construct our idea of retirement around it. Unfortunately, if you didn’t plan to save enough, then you could be restricting the golden years of your life.

It’s much better to start by first figuring out what kind of lifestyle you’d like to enjoy, and then determining what steps you’re going to need to take in order to get there.

With that thought in mind, let’s now start adding in the numbers to show how this all works together.

How to Set Your Nest Egg Savings Target

Suppose you’re comfortably living off of $60,000 per year right now. If we start by making a simple assumption that your life during retirement will be no different than it is right now, then we could calculate your retirement nest egg savings target to be:

$60,000 x 25 = $1,500,000

Why did we multiply this by 25? That number comes from something called the 4 Percent Rule. The 4 Percent Rule is a study that was published back in the 1990s and has been updated and re-validated several times since then.

Simply put, the rule states that a retiree can safely withdraw up to 4 percent from their nest egg every year (with adjustments for inflation) for at least 30 years. Therefore, if we know ahead of time how much money we’ll need every year for retirement, then we can use the 4 Percent Rule to calculate how big we need our nest eggs to be to produce that amount.

(Mathematically, dividing by 0.04 or 4 percent and multiplying by 25 is the same thing).

Now consider what would happen if you wanted to have a more ambitious retirement that consisted of more land, traveling the world, or even taking on entrepreneur-type activities. For the sake of argument, let’s say your new anticipated expenses are $100,000 per year. Using the 4 Percent Rule, this would increase your nest egg target to:

$100,000 x 25 = $2,500,000

Again, if you can save that much by the time you’d like to retire, then great! No worries. But if your number is starting to look a little bigger than you can handle, then you may need to go back and give this some thought.

What If I Need More Than 30 Years?

If you think you’ll need more than 30 years of retirement income or would just like to simply play it safe, then you could certainly choose to lower your withdrawal rate to a more conservative number such as 3.5 or even 3.0 percent.

While doing so would give you peace of mind, remember that the lower your withdrawal rate, the more this will increase your nest egg target. Using our larger target as an example, here’s how this would affect your calculations:

$100,000 / 0.035 = $2,857,143

$100,000 / 0.03 = $3,333,333

Comparing $2,500,000 against $3,333,333, you’ll have to ask yourself a personal question: Is $833,333 more in savings worth it to me to be able to retire early or have added safety?

Adjusting Your Target

For a lot of people, saving up one or two million dollars for your retirement can sound like a pretty lofty goal, especially if you haven’t been diligently saving as much you’ve probably wanted. If that’s describing your situation, then what you’re going to want to do is go back to your fundamental assumptions and make some adjustments.

For example, suppose that despite your best efforts, the greatest amount of money you believe you can save for retirement is $1,000,000. That would mean that your nest egg should be able to produce $40,000 of income each year. Would that be enough? Or would you need to consider taking more drastic steps between now and your retirement to get to where you want to be?

One thing you could definitely do is take a hard look at your current expenses and activities and look for ways to reduce them. Especially if these are expenses that would carry over into your retirement, then they would surely help to lower the amount of income you’d need.

For example, one of the oldest goals for many people is to pay off their mortgage before entering retirement. And for good reason! If your mortgage is $1,000 per month, cutting out a $12,000 expense would mean reducing your nest egg by:

$12,000 x 25 = $300,000

Cutting other expenses could also have similar effects.

Besides, you could also plan to take on some part-time work. Even if you earned $1,000 to $2,000 per month, that could reduce your nest egg by as much as $300,000 to $600,000!

All in all, determining how much money you’ll need will be a balance of supply versus demand. The more money you’re able to set aside and time you’re able to devote to saving, the higher your chances of success will be.

The most important step is to set your target, figure out what number you’d need to support it, and then decide if that target is feasible. With a goal in mind, you’ve got something to work towards, and I believe most people will take the extra steps they need to turn it into something achievable.

Contributor’s opinions are their own. Always do your own due diligence before investing.