One of the most common questions we get as financial planners is “how much money do I need to have saved before I can retire?” And the answer is one that we as financial planners commonly give – “it depends.” Determining the amount of savings you need to accumulate before retiring is highly specific to each situation. One family might be fine with $500,000 of savings while another would need to save $5 million before retiring. The good news is that you only need to know two data points and simple math to calculate an initial estimate of retirement savings needs: 1. How much recurring income will you have in retirement (Social Security, pension, rental income) and, 2. How much will you spend each year in retirement. The Retirement Income forecast is often easy to glean from historical data and estimated benefit statements. The spending forecast can be more challenging as it requires knowing what you currently spend annually and projecting how that spending may change in retirement. Annual spending amounts are not commonly known even though the data is often available in various places. A best practice is to continually collect your spending data with some automated tool like Quicken or Mint. Banks also frequently offer spending tracking tools to their customers. In absence of an automated solution, one can determine their annual spending on an ad-hoc basis by reviewing twelve months of recent bank and credit card statements. Once you have determined what your current annual spending amount is, you need to make adjustments for how the spending might change in retirement. For example, the current spending might include things that will end at some point in the future, such as a mortgage or education expenses. You now have your Adjusted Retirement Spending forecast. With this number and your Retirement Income forecast, you are ready to calculate your Retirement Savings Number. Start by subtracting your Adjusted Retirement Spending number from your Retirement Income number. This is the amount of spending not covered by recurring income that needs to be covered by your savings. Divide that number by .03 and jot it down. Do the same calculation again but divide by .05 instead of .03. This will give you a general range of what you need to have saved before retiring (see example below). It is important to know that this method will give many people a needed retirement savings range but there are individual circumstances that would cause this simplified formula to yield a range that is inaccurate. If you want to actually determine your Retirement Number versus estimate it, you should visit with your local fee-only financial planner for a customized analysis.
Retirement Income (Social Security) $40,000/yr
Adjusted Retirement Spending $75,000/yr
Low end of range of savings needed: ($75,000-$40,000) / .03 = $833,333
High end of range of savings needed: ($75,000-$40,000) / .05 = $700,000
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