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How Much Do I Need to Retire? 5 Numbers to Help You Decide
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“Remember to overestimate your expenses and build in a margin for unexpected costs and consider the impact of taxes in retirement.”
Without the right strategy, planning for retirement can be overwhelming. In this episode, you'll take the first step towards creating a personalized retirement plan simply by taking stock of five essential numbers.
“Fixed expenses” means different things to different people. Learn how to zero in on what exactly those expenses are for you. You’ll also find out how much money really goes into an emergency savings fund, and how to factor in fixed income sources like social security and (for those lucky enough to have them) pensions.
Next, our host Danny Gudorf speaks on identifying the income gap between fixed expenses and your monthly income. You'll discover strategies for filling this gap, including the optimization of investment withdrawals using the 4% rule, as well as the art of sticking to your retirement income guardrails. Finally, Danny covers what you need to know about creating a tax plan for retirement.
Key Topics:
- Fixed Expenses (2:44)
- Emergency Savings Fund (5:29)
- Fixed Income Sources (7:25)
- The Gap Between Your Fixed Expenses and Monthly Income (10:36)
- Investable Assets and How Much Income You Can Generate From Them (11:30)
- 4% Rule Versus Retirement Income Guardrails (14:48)
- Summarizing the 5 numbers (16:12)
Retirement is a significant milestone in life, one that many of us look forward to with anticipation and, sometimes, a bit of trepidation. Whether you're on the cusp of retirement or it's still a few years away, understanding the financial aspects of this new chapter is crucial. In this blog post, we'll explore the five essential numbers you need to calculate to determine if you're ready to retire. By the end, you'll have a clearer picture of your retirement readiness and the confidence to make informed decisions about your future.
Key Takeaways
Before we dive into the details, here are the core insights you'll gain from this post:
- Understand your expected retirement expenses
- Build a robust emergency fund for unexpected costs
- Calculate your fixed income sources in retirement
- Determine the gap between your income and expenses
- Assess your investable assets and sustainable withdrawal rates
These five numbers form the foundation of a personalized retirement plan. By calculating them, you'll be better equipped to answer the all-important question: "Can I afford to retire?"
The 5 Essential Numbers for Retirement Planning
1. Your Retirement Expenses
The cornerstone of any retirement plan is a clear understanding of your expected expenses. While a common rule of thumb suggests that retirees need about 75-80% of their pre-retirement income, this is just a starting point. Your actual needs may be higher or lower depending on your lifestyle and goals.
To calculate your retirement expenses:
- List all your current expenses
- Consider which expenses might change in retirement (e.g., commuting costs may decrease, while healthcare costs may increase)
- Factor in new expenses related to retirement activities (travel, hobbies, etc.)
- Don't forget to account for inflation
Pro Tip: Use a retirement budget worksheet to ensure you're not overlooking any expenses. Many financial advisors offer these tools for free on their websites.
Example:
Let's say John and Mary currently spend $6,000 per month. After reviewing their retirement goals and expected lifestyle changes, they estimate their retirement expenses to be about $5,000 per month or $60,000 annually.
2. Your Emergency Fund
An often-overlooked aspect of retirement planning is the emergency fund. In retirement, having a robust safety net is even more critical as you no longer have a steady paycheck to fall back on.
Recommended Emergency Fund: 12 months of living expenses
Why so much? In retirement, you want to avoid dipping into your investment accounts during market downturns. A substantial emergency fund allows you to weather financial storms without compromising your long-term plans.
Calculating Your Emergency Fund:
- Take your monthly expenses (from step 1)
- Multiply by 12
Example: If John and Mary's monthly expenses in retirement are $5,000, their ideal emergency fund would be $60,000 ($5,000 x 12).
Where to Keep Your Emergency Fund: Consider high-yield savings accounts or short-term, low-risk investments like Treasury bills. The goal is to balance accessibility with a modest return to help offset inflation.
3. Your Fixed Income Sources
Fixed income sources form the bedrock of your retirement income strategy. These are the reliable, steady streams of income you can count on month after month. The most common sources are:
- Social Security benefits
- Pension payments (if applicable)
- Annuity payments (if you've purchased an annuity)
How to Calculate Your Fixed Income:
-
Social Security: Visit the Social Security Administration's website (ssa.gov) and use their benefits calculator. You'll need to create an account to get personalized estimates based on your earning history.
-
Pension: Contact your pension plan administrator for an estimate of your monthly benefit. Be sure to understand your options for single-life vs. joint-and-survivor benefits if you're married.
-
Annuities: If you have an annuity, review your contract or contact your provider for details on your guaranteed income stream.
Example: Let's say John and Mary's fixed income sources break down as follows:
- Social Security (combined): $3,000/month
- John's pension: $1,000/month
- Total Fixed Income: $4,000/month or $48,000/year
Pro Tip: Consider delaying Social Security benefits if possible. For each year you delay beyond full retirement age (up to age 70), your benefit increases by about 8%.
4. The Income Gap
Now that you know your expenses and your fixed income, it's time to calculate the gap between the two. This gap represents the amount you'll need to generate from your savings and investments each year.
To calculate your income gap:
- Take your annual expenses (from step 1)
- Subtract your annual fixed income (from step 3)
Example: John and Mary's calculations:
- Annual expenses: $60,000
- Annual fixed income: $48,000
- Income gap: $12,000 per year
This $12,000 gap is what John and Mary need to generate from their retirement savings each year to maintain their desired lifestyle.
Understanding the Importance of the Income Gap: The size of your income gap directly impacts how much you need to have saved for retirement. A smaller gap means less pressure on your investment portfolio, while a larger gap requires a more substantial nest egg or potentially adjusting your retirement expectations.
5. Your Investable Assets and Withdrawal Strategy
The final piece of the retirement readiness puzzle is understanding your investable assets and determining a sustainable withdrawal strategy.
Investable Assets:
These are the funds you've accumulated in various retirement accounts such as:
- 401(k)s
- Traditional and Roth IRAs
- Taxable investment accounts
Add up the balances of all these accounts to get your total investable assets.
Withdrawal Strategy:
Once you know your total investable assets, you need to determine how much you can safely withdraw each year. This is where things get a bit more complex, and strategies can vary based on individual circumstances.
The 4% Rule: A common starting point is the "4% rule," which suggests that you can withdraw 4% of your portfolio in your first year of retirement, then adjust that amount for inflation each subsequent year. However, this rule has limitations and may not be suitable for everyone.
Retirement Income Guardrails: A more nuanced approach is using "retirement income guardrails." This strategy allows for higher initial withdrawal rates (potentially up to 5.4% or more) but includes rules for adjusting withdrawals based on portfolio performance.
Example: Let's return to John and Mary. They have $500,000 in investable assets.
- Using the 4% rule, they could withdraw $20,000 in the first year ($500,000 x 4%)
- Using a 5.4% withdrawal rate with guardrails, they could potentially withdraw $27,000 in the first year ($500,000 x 5.4%)
In this case, the guardrails approach would cover their $12,000 income gap with room to spare, while the 4% rule would fall short.
Important Considerations:
- Your optimal withdrawal rate depends on factors like asset allocation, retirement length, and risk tolerance.
- Regular review and adjustment of your withdrawal strategy is crucial throughout retirement.
- Consider working with a financial advisor to develop a personalized withdrawal strategy that aligns with your specific situation and goals.
Putting It All Together: Can You Afford to Retire?
Now that you've calculated these five essential numbers, you're in a much better position to answer the question, "Can I afford to retire?" Here's how to interpret your results:
-
If your fixed income plus sustainable portfolio withdrawals cover your expected expenses (including a buffer for unexpected costs), you're likely in a good position to retire.
-
If there's a significant shortfall, you may need to consider:
- Delaying retirement to save more or increase Social Security benefits
- Reducing your expected retirement expenses
- Exploring part-time work in retirement to supplement your income
- Reassessing your investment strategy to potentially increase returns (keeping in mind the associated risks)
Remember, retirement planning is not a one-time event. It's an ongoing process that requires regular review and adjustment as your circumstances change.
Additional Considerations for a Successful Retirement
While the five numbers we've discussed form the core of your retirement plan, there are other important factors to consider:
Tax Planning in Retirement
Understanding how taxes will impact your retirement income is crucial. Different income sources are taxed differently:
- Social Security benefits may be partially taxable
- Traditional IRA and 401(k) withdrawals are typically fully taxable
- Roth IRA withdrawals are generally tax-free
Strategic withdrawals from various accounts can help minimize your tax burden in retirement.
Healthcare Costs
Healthcare is often one of the largest expenses in retirement. Be sure to factor in:
- Medicare premiums and out-of-pocket costs
- Long-term care insurance or potential long-term care expenses
- Health Savings Account (HSA) contributions if you're still working
Inflation
While we touched on inflation earlier, it's worth emphasizing its impact on your long-term retirement plan. Ensure your investment strategy and withdrawal rate can keep pace with rising costs over time.
Estate Planning
Consider how you want to pass on your assets to heirs or charities. Proper estate planning can help minimize taxes and ensure your wishes are carried out.
Conclusion: Your Path to a Confident Retirement
Calculating these five essential numbers – expenses, emergency fund, fixed income, income gap, and investable assets with a withdrawal strategy – provides a solid foundation for your retirement planning. By understanding these figures, you're taking a crucial step towards a confident and secure retirement.
Remember, retirement planning is complex, and everyone's situation is unique. While these calculations give you a good starting point, consider working with a financial advisor who can provide personalized guidance and help you navigate the nuances of retirement planning.
Your dream retirement is within reach. By taking the time to understand your financial picture and make informed decisions, you can look forward to this next chapter of life with excitement and peace of mind.
Ready to take the next step? Consider scheduling a retirement assessment with a financial professional who can help you refine your plan and ensure you're on track for the retirement you've always envisioned.
Schedule your free retirement assessment today and take control of your financial future!
*This blog post is based on the insights shared by Gudorf Financial Group. For personalized advice tailored to your unique circumstances, always consult a financial, legal, or tax professional.*