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Retirement: How Much is Enough?

Written by Nickel - 15 Comments

Retirement: How Much is Enough?

The topic of how much money you need to retire is of great interest to me — and, presumably, many of you. Can you retire with a million dollars in the proverbial bank? More? Less? As with many things, the answer is usually “it depends.”

A popular approach to estimating how much you need to retire is to estimate your annual post-retirement living expenses and then multiply by 25. That’s the amount of money you’d need to have socked away if you were willing to assume a 4% “safe withdrawal rate” (SWR).

In other words, if you need $40k/year, you’ll need an investment portfolio of roughly $1M. And if you need $100k/year, you’ll need a $2.5M nest egg. Simple enough, assuming that your portfolio will actually support 4% withdrawals without getting depleted early, and that you’ve accurately estimated your needs.

According to a recent study by benefits consulting firm Aon Hewitt, an alternative way of expressing your retirement needs is as a multiple of your final working salary.

Based on their results, an average worker retiring at age 65 needs to have eleven times their final salary stashed away (in addition to Social Security benefits) to be able to maintain their current standard of living. This analysis takes into account both inflation and anticipated post-retirement medical expenses.

If 11x your final salary is too steep, you can reduce the required amount to 9.4x by delaying retirement to age 67. Or, if you’d like to accelerate your retirement to age 63, you’ll need 13.5x your final salary. This is considerably less than the 25x rule of thumb based on the 4% SWR mentioned above.

Interesting, but also flawed. The reason I say this is that you can’t reasonably expect to translate someone’s salary into a required nest egg without knowing more about how they spend it. Consider the following…

Bob and Mike both spend identical amounts to support their lifestyle — let’s say $75k/year. But when you dig deeper you learn that Bob is living paycheck-to-paycheck on an annual salary of $75k whereas make is making bank at $150k/year and living well below his means.

Using a whatever-number-you-choose-times-salary rule, Mike’s retirement needs would appear to be twice those of Bob, but clearly that’s not the case. They both spend the same to support their lifestyles so, assuming that they want to continue living at that standard, they’ll both have similar needs regardless of how big their current paychecks are.

Anyhoo… Ignoring that (major) flaw in Aon Hewitt’s reasoning… How many people are actually on track to save this much? According to survey results, the typical “full-career” employee is on track to save 8.8x their final pay. That’s a bit better than a couple of year ago, but still well short of 11x — and even further short of the old school 25x rule of thumb.

What about you? Have you done the math and set a specific numeric goal for your portfolio? If so, are you on track for a successful retirement? If not, what are you waiting for?

Wherever you’ve set the number, if you’re not on track to make it there, there are some things you can do. The simplest approach is to scale back your standard of living, which has a dual benefit. By making do with less you can save more now and you’ll need less later.

Source: NY Times

Published on July 9th, 2012
Modified on July 27th, 2012 - 15 Comments
Filed under: Retirement, Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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15 Responses to “Retirement: How Much is Enough?”

  1. 1
    Mark Says:

    2 million is a good number, it is overkill since I will have a small pension on top of that, but once I hit 2 million the stock market can do pretty much whatever it wants and I will be fine.

  2. 2
    Matt Henderson Says:

    What can get tricky, though, is that the 4% should be relative to the current level of your savings, which could fluctuate quite a bit from year to year (depending on your asset allocation). I guess that’s why, for planning purposes, one might consider putting part of one’s savings in an annuity).

    For myself though, I’ve long been an investor in the “Permanent Portfolio” (cash, stocks, gold, long-bonds) and hopefully that will continue to prove as low-volatility as it has in the past.

  3. 3
    Lance @ Money Life and More Says:

    I’ve read so much lately about having a number but I don’t have one yet. It is on the list of things to do. I think I’ll be safe though and I still have around 40 years to go.

  4. 4
    Steve Says:

    A rule of thumb like “11x final income at 65″ can only be applied to a stereotypical, average consumer. Said SAC doesn’t know their own expenses, and as such would have to make some stuff up (probably wildly underguessing). Then those errors would get magnified when the formula, which has its own assumptions and probabilities, is applied. At least the SAC probably knows about how much their income is, reducing the error.

    Nevertheless, I agree that if you do know your expenses, you’re probably better off using that. Or if your expenses are much lower (or higher) than the group of SAC’s with your income level, you would be best served by measuring or making a good effort of estimating your expenses.

    The 25x number doesn’t include any social security. I assume the 11x number does though, which is a huge difference.

  5. 5
    Kurt @ Money Counselor Says:

    I think all of these ‘rules of thumb’ about the size of one’s needed retirement fund are essentially hooey, useful for planners and individuals lacking the patience to do the hard work of a personalized retirement plan.

    As you point out, everyone’s situation is different. Depending on where one wants to live and how one wants to live in ‘retirement’ (I’m not sure what that outmoded word even means anymore), nest egg needs can vary widely. I intend to work, at least part time, as long as I have a few functioning brain cells and can get myself out of bed on my own. That aim of course throws a big monkey wrench into every retirement rule of thumb.

    You gotta sit down with a spreadsheet, decide on your goals, and do the math! Then ignore the “experts.”

  6. 6
    Evan Says:

    I am way too far away to have a “number” but I never understood the SWR. It just doesn’t make sense to me. If you are 64 and spending $100k/yr when you turn 65 it isn’t going to magically drop to whatever 4% of your portfolio is.

    Then add in the speed bump of whether your portfolio throws off 4% of dividends and/or rental income and I just can’t comprehend planning that way.

  7. 7
    Nickel Says:

    Evan: If you don’t adjust your spending to what your portfolio will support once you retire, then you either need to keep working or get comfortable with the idea of running out of money.

    The 4% rule is based on a series of simulations that includes market fluctuations, etc. That being said, past performance doesn’t guarantee future results and all that jazz.

  8. 8
    Evan Says:

    I understand how the 4% came about I am just saying it is pretty irrelevant in terms of reality.

  9. 9
    Matt Henderson Says:

    Evan: Why would it be irrelevant in terms of reality? If you have an amount of capital, and if that capital needs to sustain you indefinitely, then you must adapt your spending to stay within 4% per year. That *is* your reality. If you don’t, and if you spend more than the 4% per year (or buy an annuity), then your probability of running out of money will increase with the level of your excess drawdowns.

  10. 10
    Nickel Says:

    Evan: Saying it’s irrelevant is just silly. As Matt pointed out, this is reality we’re talking about. If you fail to plan and keep on spending as if you’re still working even though you’re living off a too small nest egg, then you’re screwed — and your spending WILL eventually adjust because you’ll run out of money. It’s a planning tool. It tells you how much you’ll need if you want to keep spending at a certain level. It’s then up to you to make it happen. If you don’t then you’re in for a rude awakening.

  11. 11
    Evan Says:

    I don’t think my statements are silly at all. I am not disagreeing that it is a recipe for disaster all I am saying is what is more likely:
    Person A has $1mil in savings and spends 100K per year.
    1) He cuts spending down to 40K
    2) He keeps spending 100K and is screwed in 8 to 10 years.

  12. 12
    Nickel Says:

    Right. One of those approaches is “safe” and the other is not. Hence the term safe withdrawal rate. It has nothing to do with what is likely. It has to do with what is (arguably) safe and sustainable. The approach isn’t invalidated simply because someone ignores it and winds up eating cat food later in life.

  13. 13
    Mr Mike Says:

    My plan is as simple as it gets for my wife and I. We plan on spending more in retirement because that is why we saved so much. We will be spending $20K more per year in order to travel and do more of what we can in our free time. With pension and Social Security our tapping of Retirement monies will be in the 1 to 1-1/2% of our accumulated portfolio. So we are far below the “safe withdrawal rate” (SWR). With that being said we can make adjustments as we need to and still be far ahead of the game outside any “economic catastrophe” that we face in the near future.

  14. 14
    David Bressler Says:

    I understand all the “math”, but don’t understand the logic.

    Why is so much retirement planning done with a focus on “how much money you need” (as a lump sum), instead of investing for income, and then managing your “retirement” income earned from your portfolio + pension + social security vs. what you need to retire.

    db

  15. 15
    Amelie - hr consulting Says:

    Not everybody retires by choice. Sometimes people are forced to do so due to illness or physical problems that prevent them from continuing in their careers, or financial considerations such as layoffs.

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