How Much Will You Need for Retirement?

Have you ever wondered how much money you'll need for retirement? Many of us are saving in 401K’s and IRA’s assuming that come retirement day, we’ll be able to sit back and enjoy our golden years. The problem with that scenario is that without calculating how much you’ll need, there’s a good chance you will not hit the mark—in other words, you’ll wind up working when you should be relaxing.

There are some factors that you must keep in mind that will affect your retirement needs before, and during retirement. One BIG factor that most people forget about, though I don’t understand how, is inflation. Inflation, in simple terms, is the devaluation of the dollar—what you can buy for a dollar today will cost much more tomorrow.

For instance… let’s assume that you will be withdrawing $80,000 every year, in today’s dollars, and that inflation will be 2.5% (that’s why the later you retire, the more you'll actually need), if you wait until next year to start withdrawing, you will need $82,000 to have the same purchasing power.

To keep things simple, there’s an assumption that you will be withdrawing the same amount every year. It’s not the most accurate assumption since this changes as your needs change, but if you’ve never calculated how much you need to retire, this is a good number to start off with. There is a bit of math involved but you don’t need to be a rocket scientist to come up with a rough estimate of the money you’ll need.

Below are the points you need to factor in and the steps to do your own financial calculations:

#1. Spending: You can’t know how much you'll need for retirement until you know how much you will spend. I realize that we’re talking about future spending, but you must make an educated estimate of what you’ll be doing and buying. I recommend you take what you spend now and adjust for inflation.

Remember, when you retire you'll have more time to spend money, so don’t think you’ll spend less. Also, as you get older, you may have to help your kids, grandkids, and you might have added medical expenses. Most people don’t really know how much they spend, but a simple method is to average your total bank withdrawals over the last 12 months and multiply it by 2.5%. Do this for each assumed year of retirement. For example:

Year #1: $50,000 x 2.5% = $51,250; Year #2: $51,250 x 2.5% = $52,531…etc.

You can actually use an online calculator to do this for you, but at least you now understand the concept of how inflation works.

#2. Estimate Your Retirement Income: When you retire, you’ll have social security and possibly a pension. There are also other ways to generate income during retirement. How much income will you have? For our example, let’s assume you’ll have $80,000 worth of spending the first year of retirement and you have social security and pension income of $30,000. You can see that you will need to come up with an extra $50,000 in order to meet your annual income needs.

#3. Do the Math: We know that based on this scenario, you will need an extra $50,000.  Now we have to figure out how much to invest in order to fill that $50,000 gap. You do this by simply taking the $50,000 and dividing it by the return you think you’ll earn on your investments during retirement (let’s say something conservative like 5%). So, if we take $50,000 and divide it by 5% – you get $1,000,000. That means you have to have $1,000,000 saved and getting a 5% rate of return in order to earn $50,000. Now you have your target – $1,000,000.

The next step is to get with a financial expert, and talk to them about the many different financial vehicles that will help you achieve the amount of savings you’ll need to accumulate in the timeframe you have available. Remember, time is NOT on your side and the longer you wait, the more money you’ll need; so don’t procrastinate.