Retirement: How Much will you Really Need?

brennan mccarthy, CFP®

Retirement planning is a topic that often invokes a mix of anticipation and anxiety. The central question is simple yet profound: “How much money will I need to retire?” While the answer might seem straightforward, it involves a complex mix of factors.

The Rules of Thumb

Financial advisors often shy away from one-size-fits-all formulas when determining retirement needs. After all, life is rarely that simple. Each individual’s retirement plan is as unique as their fingerprint, influenced by their lifestyle, goals, and financial circumstances.

However, for those seeking a quick estimate, certain rules of thumb can provide a starting point. One popular guideline suggests that retirees will need enough savings to support approximately 80% of their pre-retirement income. This accounts for a decrease in certain expenses post-retirement, such as commuting costs and (typically) lower taxes, but also factors in that you'll no longer be saving part of that income.

The 5% Rule

To refine this estimate further, financial planners sometimes employ the “5% rule.” This rule posits that retirees should be able to withdraw 5% of their retirement portfolio annually to maintain a comfortable lifestyle without depleting their nest egg too quickly.

Let’s consider a hypothetical couple with a pre-retirement income of $250,000. According to the 80% guideline, they would aim for a retirement income of $200,000. Social Security benefits, which most Americans are entitled to, would cover a portion of this. Assuming the couple receives $60,000 annually from Social Security, their retirement portfolio would need to generate $140,000 per year.

Using the 5% rule, we can calculate the necessary starting balance for their retirement fund:

Required Income from Savings = Total Retirement Income − Social Security Benefits

Required Income from Savings = $200,000 − $60,000 = $140,000

Starting Balance = Required Income from Savings/.05 = $140,000 / .05 = $2,800,000

Therefore, the couple would need a retirement portfolio starting balance of $2,800,000 to safely retire.

Personalizing Your Retirement Plan

While these rules provide a framework, it’s essential to personalize your retirement strategy. Consider factors such as your health, expected lifespan, desired retirement age, and the kind of lifestyle you wish to maintain. Additionally, account for inflation, investment returns, and potential healthcare costs.

Retirement planning is not a one-time calculation but a dynamic process that evolves with your life. By starting with general guidelines and then tailoring them to your situation, you can develop a more accurate and meaningful retirement plan. Remember, the goal is not just to retire, but to retire with confidence and security.