Planning for retirement is difficult to navigate, and many people struggle to answer the question, “How much do you need to retire?” This important question requires careful consideration and calculation. However, the good news is that once you know two key pieces of information, calculating your retirement needs becomes surprisingly straightforward. Today we walk you through the process step by step, so you can gain a better understanding of what it takes to retire comfortably.
Determining Your Retirement Expenses
The first step in calculating your retirement needs is to determine your expected expenses during retirement. There are two approaches: the bottom-up approach and the top-down approach.
The bottom-up approach involves creating a detailed budget by listing all your expected expenses in retirement, such as groceries, bills, travel, and property taxes. Assign a dollar amount to each item and add them up to get your total retirement expenses. While this method provides a precise figure, it requires careful planning and consideration of various expenses.
The top-down approach is a simpler alternative. Start by considering your current take-home income and determine if it covers all your needs. Then, subtract any future expenses that will no longer be necessary in retirement, such as a mortgage or college savings contributions. This approach gives you a rough estimate of your retirement expenses.
Calculating Portfolio Needs
Once you have a figure for your retirement expenses, the next step is to calculate the portion that needs to be covered by your portfolio. This step considers any other sources of income you may have during retirement, such as pensions, Social Security benefits, rental income, or part-time work.
For example, if your retirement expenses amount to $100,000 per year and you receive $70,000 per year from non-portfolio income sources (e.g., pensions and Social Security), then your portfolio will need to cover the remaining $30,000.
Applying a Withdrawal Rate
With the amount needed from your portfolio identified, you can now apply a withdrawal rate to determine the size of your retirement portfolio. The withdrawal rate is the percentage of your portfolio that you can safely withdraw each year to cover your expenses without running out of money during retirement.
A common withdrawal rate is 4%, but it’s essential to adjust this rate based on factors such as your age, portfolio mix, and inflation expectations. In the example above, if you can safely withdraw 5% per year, you would need a portfolio of $600,000 ($30,000 ÷ 0.05) to cover your retirement expenses.
Considering Other Factors
While the process outlined above provides a good starting point, it’s essential to consider other factors that could impact your retirement needs. Some of these factors include:
a. Taxes: Different income sources may be subject to varying tax rates, so be sure to account for this in your calculations.
b. Inflation: Your expenses and income sources may change over time due to inflation, so adjust your calculations accordingly.
c. Marital Status: Your tax situation may differ depending on whether you are single or married, impacting your overall retirement expenses.
d. Insurances: Plan for any health insurance or long-term care expenses that may be necessary during retirement.
e. Lifestyle Changes: Account for different phases of retirement that may incur varying levels of expenses.
While calculating your retirement needs may seem complex at first, understanding two key pieces of information – your retirement expenses and the portion that needs to be covered by your portfolio – can make the process surprisingly straightforward. By using a withdrawal rate and considering other factors, you can get a solid estimate of how much you need to retire comfortably.
It’s essential to review and adjust your retirement plan regularly to account for changing circumstances and goals. Seeking professional financial advice can also help ensure that your retirement plan aligns with your unique situation and objectives. With careful planning and a clear understanding of your retirement needs, you can embark on your retirement journey with confidence and financial security.
Need help with your retirement?
Work directly with a licensed financial advisor at Root. Book a no-obligation initial call now so we can show you how we’ve helped hundreds of people just like you build a retirement they love.