I am often asked, “How much do I need in order to retire?” One million? Two million? There is no simple answer. But this is a very good question. Essentially, each person’s answer will depend on a variety of factors.
How much you need depends on how much you will spend
First we need to look at your annual expenses. Imagine you currently have a job, a mortgage and take a yearly vacation. You save for retirement and pay taxes. These expenses will change upon retirement. You may pay off the mortgage, take a trip or two and stop saving for retirement. Your tax rate may decrease. Evaluating your present expenses and anticipating what they will be later is a key first step in answering the question, “How much of a nest egg will I need at retirement?”
Inflation is a significant risk to retirees. When we stop working, expenses tend to rise faster than income (hence the familiar phrase, “living on a fixed income.”) The cost of living adjustments included in Social Security do not give sufficient protection from rising prices, especially healthcare costs which increase more rapidly than overall inflation and consume a greater percentage of our budget as we age.
How much will your investments grow in retirement?
Next, we must look at how your investments are positioned. Are you invested for growth or income? One of the key reasons we save and invest is to ensure a source of income that we hope will keep pace with inflation. How long our investment nest egg lasts depends on our expenses, the rate of inflation, how we’re invested and how long we live – a fairly complex set of factors.
Increased longevity plays an important role
Nowadays people are living longer. Accordingly, the “calculus of retirement saving” has undergone a staggering change. Most people are unaware of the implications. People used to work for 40-50 years, and then retire for 10 or 20. Now people envision working 40 years or even less, retiring sooner, and can live for another 30 years or more. The whole paradigm has shifted.
Young people getting married and having kids may not start saving right away. But this means it can be unrealistic to think you can save for 20 years and retire for 30. The biggest single factor in reaching our retirement savings goal is time, so starting as soon as possible is a must.
Not only is there no simple answer to the question, “How much do I need to retire?” the answer will be different for each person. That’s why it’s so important to seek the help of a professional. What you want your life to “look like” depends on your values and priorities. First, do a thorough analysis of your present expenses and an estimate of expenses at retirement. Factor in inflation. Then come up with a savings goal and investment plan that increases the probability you will have enough for the number of years you expect to live.