How much do I need to be able to retire?
Everyone wants to know the magic number that is needed to be able to retire. First, we have to clarify what number we’re talking about – is it the amount of money that needs to be saved? Or is it the income that needs to be generated? Because it is easiest to relate to the amount of income coming into your household, let’s focus on the income number.
Second, most people want to know the amount of income needed today because it is easily relatable; however, if you are young (30, 40s, or even 50s), your number is going to look different than a 62 year old ready to retire tomorrow because of inflation and income adjustments. Inflation is the reason $1 today is worth more than $1 in 20 years (think about what it used to cost you to go to the movies as a teenager vs. now). Income adjustments will happen throughout your career – hopefully in the form of raises. If you have more time until retirement, you have more time to earn a higher income, allowing you to adjust your lifestyle upward but also meaning you will have more income you need to replace in retirement.
The income number is not the same for any one family meaning there is no one rule of thumb to follow such as the old adage of needing 70% of current income. The amount you need depends on many factors including how much debt you will maintain, where you will live (potential taxes owed), and the source of your income (taxable at income or capital gains rates).
We assume everyone maintains their current standard of living into retirement. With this assumption, to get a general idea of income need, take your current gross income and subtract expenses that you know will go away in retirement. Some of these expenses include retirement plan deferrals, FICA taxes, HSA contributions, and principal/interest mortgage payments (if the mortgage will be paid off in retirement). Keep in mind that this equation does not include potential changes to health insurance costs, additional travel expenses, or income taxes. Also, the amount of income needed will change if you have young kids you still fully support but who will be independent when you retire.
Once you have an idea of the approximately income you will need, you can try living on your “new” income as a test to determine if you need to adjust up or down. Additionally, fill out a detailed budget to have a better idea of your actual expenses when going into retirement.
Mary earns $100,000 before taxes, contributes the IRS maximum to her company 401k, makes a $100/pay contribution to her HSA, and will have her mortgage paid off when she retires. She expects to travel in retirement because she isn’t able to now. Mary expects $25,000 from Social Security; she has a part-time job lined up for retirement that will earn her $15,000/year. She will fill the rest of her needed income from her investment savings.
$100,000 – $24,500 – $2,600 – $24,000 = $48,900 + $10,000 = $58,900
Gross income – IRS retirement deferral maximum – HSA contributions – principal/interest mortgage payments = gross income need
Gross income need + additional travel expenses = total gross income need in retirement
Mary needs to replace approximately $58,900 gross in retirement. How much does Mary need to take from her investment savings? $18,900.
$58,900 – $15,000 – $25,000 = $18,900
Gross income need – part-time job income – Social Security income = amount needed from investment savings