How much money will I need to retire? This is the question that started my investment education journey. Until then, I had been putting money into my retirement accounts with the vague idea that it would grow to some mysterious amount by age 65, at which point I would hopefully have enough to stop working.
When I turned 35, I started to ask myself if I was on track for retirement. I wanted to know earlier rather than later if I needed to increase my contributions to my retirement accounts since I still had time for compounding to work its magic.
Imagine my surprise when I discovered that retirement planning was not the great mystery I thought it was. While some aspects of retirement planning can be complicated, figuring out how much you need to save is not one of them.
You need to know two important numbers: how much you will have when you retire, and how much you plan to spend in retirement. Let's explore the tools you can use to determine how much money you will need to retire.
The Rule of 72
The first tool in the retirement toolkit is the rule of 72. This tool is for quick, back-of-the-envelope estimates to determine when your investment balance will double. The rule goes like this: divide 72 by the expected return to solve for the number of years it will take for your investment to double. So if you have a 7% return, you can calculate 72/7=10 years.
You can then use this to determine your approximate balance at retirement. If you currently have $150k in retirement accounts and are 30 years from retirement, then you will likely have $1.2 million at retirement.
$150,000 x 2 = $300,000 at 10 years
$300,000 x 2 = $600,000 at 20 years
$600,000 x 2 = $1,200,000 at 30 years
So why do we need fancy retirement calculators if we can just multiply by 2 a few times? Because this calculation doesn't take into account your ongoing contributions. It can be a quick way to see how much you could have if you stopped contributing today, but it isn't a practical way to predict your retirement balance.
Retirement Calculators
Retirement calculators use a compound interest with ongoing contributions calculation to determine the expected growth of your investment. The estimate requires you to choose an average rate of return and a periodic contribution amount.
The shortfall of this calculation is that your contributions might not be the same for your entire career. And as you will quickly learn after investing for a short time, returns are inconsistent.
Still, it can be a helpful tool to estimate how much you might have in retirement if you invest a certain monthly amount. An average return of 7% is a common assumption over your investing life. The market returns an average of 10% per year over long timelines, but inflation is 3% on average.
You can use our free investment contribution calculator to see how much you will likely have when you retire. This will tell you the first number you need: how much you will have at retirement.
The 4% Rule
Once you know how much you will have in retirement, you must determine if it is enough for your retirement spending. The 4% rule is a guideline that can help you calculate a safe withdrawal rate in retirement. In other words, how much can you spend without running out of money?
Again, there are assumptions. The guideline is based on a study by Bill Bengen that looked at thirty-year periods throughout history using historical returns and inflation to determine a safe withdrawal rate. These periods include extreme financial events like the great depression and high inflation in the 1970s and 1980s. The portfolio assumes 50% large-cap stocks and 50% intermediate treasuries. There is also an assumption that retirement lasts 30 years.
With these assumptions, Bill Bengen determined that you can safely withdraw 4% of your portfolio, with an annual raise matching inflation, and not run out of money for 30 years. Based on this rule, if you want to live on $60,000 per year in retirement, you will need $1.5 million in your portfolio. If inflation is 3% that year, you can withdraw $61,800 in the second year of retirement.
Since his initial research, Bill Bengen has examined variations of his initial assumptions. He investigated what happens if you change asset allocation by including small and mid-cap stocks in the portfolio. He also examined portfolios with up to 75% stock allocations. The resulting safe withdrawal rate was as high as 4.9%. He also studied a shorter and longer time horizon. A 20-year retirement raises the safe withdrawal rate to 5.1%, while a 45-year time horizon decreases the rate to 3.5%.
This safe withdrawal rate does not include any pensions or social security income. It simply determines the amount of money you can withdraw from your investment accounts without depleting them.
You can use our retirement income calculator to determine your annual income in retirement based on a starting portfolio balance. It assumes a 5% return in retirement and gives you both a 3% and 4% withdrawal plan to consider. It also includes your annual portfolio balance to track when your portfolio will likely be depleted. Hang on to this safe withdrawal number, because we'll come back to it.
Retirement Expenses
Determining how much you are likely to spend in retirement is the hardest part of this exercise. If you are unsure of your retirement expenses, a common guideline is to assume that your budget will be 80% of your current annual income.
Why assume a reduced percentage? For one thing, you will no longer have to pay FICA (payroll taxes for Social Security and Medicare), which are currently 7.65% if you have an employer or 15.3% if you are self-employed. You will also no longer be saving for retirement, so the 10-15% you have hopefully been contributing to retirement will disappear from your budget.
You may also be able to reduce your expenses by no longer having a mortgage, car payment, student loans, or children to support. However, your medical expenses will likely increase, and you may also want to travel. Some people reduce their costs by relocating to a lower-cost-of-living area or country.
If you want to play it extra safe, you can always use your current income. As you approach retirement, you will likely have a better idea of your retirement expenses and be able to plan more realistically.
How Much Money Will I Need To Retire?
The next step is to bring it all together. Knowing how much you will have at retirement, how much you can safely spend, and your expected retirement expenses will allow you to answer this important question: How much money will I need to retire?
If your retirement expenses are less than the safe withdrawal rate for your expected portfolio balance, you can breathe a sigh of relief. Keep up the good work with your contributions!
If your retirement expenses are greater than your safe withdrawal rate, you may want to buckle down and figure out a way to reduce your budget and contribute more to your retirement accounts. You can check out our blog post on what to do when you start investing late if you are feeling behind.
Don't forget to account for any social security or pensions you may receive. In reality, your retirement expenses need to be less than the sum of your safe withdrawal rate plus any additional income you may receive.
Young investors may prefer to ignore social security since its future is constantly in question. However, most resources suggest that social security will likely provide a reduced benefit to future generations - possibly 75% of the current promised payments.
Once you have your plan outlined, you can use a Monte Carlo simulation to see if your plan is likely to hold up in future financial environments.
Monte Carlo Simulations
While the 4% rule looks back at historical data, the Monte Carlo simulation attempts to look forward and predict the future. A Monte Carlo simulation tests the probability of success of your retirement plan in a variety of different scenarios (with success being defined as not running out of money).
The simulation tests your plan under variable market returns, inflation, life expectancy, and withdrawal rates. The result is given as a percentage of how many scenarios result in success. Generally, anything above 80% is considered a good plan.
If you want a more in-depth explanation of Monte Carlo simulations, check out Episode 18 on the Retirement Planning Education podcast. The host, Andy Panko, provides a valuable tip regarding how to use a Monte Carlo simulation. He suggests that you consider "failures" as a scenario where you must adjust your plan, rather than a complete failure. If your plan fails in 20% of scenarios, it simply means that there is a 20% chance you will need to tweak your strategy.
Andy also suggests that a Monte Carlo simulation should be run periodically to evaluate the trajectory of your plan as real historical data replaces projected data in the simulations. If your success percentage is decreasing over time, you may need to reduce your spending, adjust your allocation, or find a way to supplement your income. If the success percentage stays the same or increases, you may be able to spend with more confidence.
A few apps and websites are available if you want to see the probability of your plan succeeding.
FIRECalc is a free website that can be used without creating an account or linking your data. You can manually input your numbers to see your results. The formatting can seem overwhelming, but the text is informative and explains the assumptions in the calculations. The tabs at the top of the page allow you to navigate to different planning topics.
The FIRECalc simulation is not a true Monte Carlo as it uses historical data rather than projected scenarios. Still, it is a useful tool for retirement projections and displays results as a percentage of success, just like a Monte Carlo simulation. It runs slightly over 100 simulations of historical data each time and provides results in today's dollars.
Empower has a free app that tracks your financial net worth through your linked accounts, although you can manually add data if you prefer. The retirement planner tool allows you to modify variables such as expected retirement date, annual contributions, and retirement expenses. The simulation runs 5,000 scenarios and provides a percentage of success. The simulation also provides projected portfolio balances in today's dollars based on the median and poor outcomes.
While the app is fantastic (and free), the advisory services offered through Empower are quite expensive. Using the app does not obligate you to use their advisors, but don't be surprised if you get a few phone calls when you first sign up for the app. The app also has a portfolio analyzer tool that helps you evaluate your overall allocation and risk.
Boldin (formerly New Retirement) also has a Monte Carlo simulation, but it is only available with the PlannerPlus subscription ($120/year). The simulation runs 1,000 scenarios and provides a percentage of success. It allows you to view projections in "today's dollars" and "future dollars".
One caveat is that its "optimistic" default setting is still quite conservative, assuming a rate of return of 5% throughout your investing lifetime. So don't feel bad if the "optimistic" projection seems far from optimistic and the "pessimistic" projection, which assumes a 2% return, causes you to question if you will ever be able to retire.
A unique feature of Boldin is its Roth Conversion simulator which allows you to optimize Roth conversions with various strategies (for example, with tax bracket limits or with lowest lifetime tax liability).
Hire A Professional
As you approach retirement, it can be prudent to have an extra set of eyes look over your plan. Speaking to a financial advisor can help you find blind spots and identify weaknesses in your plan that you had not considered. Financial advisors can be especially helpful for tax planning, which has many moving parts that can impact each other. Look for an advice-only financial planner that you pay an hourly or flat rate to review or develop your plan.
There are two networks I would consider when seeking a financial planner. Advisors at Nectarine charge $150/hour. Advice-Only Network has a variety of payment models, including hourly, flat fee, and subscription memberships. Both of these networks avoid assets-under-management fees and commissions that can cause a conflict of interest for the advisor.
Financial Freedom
Planning for retirement doesn't have to be a mystery. Determining how much money you will need to retire is a good first step toward financial freedom. Inevitably, there will be a few surprises, so stay flexible and be willing to adjust your plan.
Embrace the journey, and remember that small, consistent actions can lead to significant results. The earlier you start investing, the easier it will be to reach your goals. If you aren't sure how to start investing, don't stress - we've got you back. Check out our free investing course to dive in and start building that financial freedom today!
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