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How Much Will I Need to Retire?

I have often wondered how much I would need to retire and I’m sure you have too. It is a difficult question to answer. In my case, I will be getting a pension from the US Government. That is good, but it adds a complexity to the problem.

The main question that has to be answered first is how much money do you need to live on? This is a deeper question still, because so many things go into that answer. Some things to think about.

Will you have a company subsidized health plan that can go into retirement? If not, this could be a much bigger expense than you are paying now.

Your mortgage payment? Will you still owe on your house? Depending on the interest rates at the time of your retirement, you could refinance and get your monthly payments down. That depends on what your situation is right now. Are you in a fixed rate 15 year mortgage? If not, get one quick. If you will have your home paid off, that is fantastic!

So how much money will you need to have saved for retirement? Dave Ramsey explains it this way, and it finally made sense to me, to hear it explained in such simple terms.

Let’s use an example.

In our example, John is retiring with a pension of $40,000 per year. He has determined that he could comfortably live on $80,000 per year. John has been saving money in a Roth IRA for many years. The question is, how much does he need in that Roth IRA? By the way, if you need information on what a Roth IRA is, go to these links for a post I wrote called 16 Roth IRA Facts. According to the way Dave Ramsey explains it, John would need an amount that could return $40,000 per year in gain, leaving the base amount to continue to grow. He says we should plan on 8% – 12% gain, if invested in a good growth mutual fund. Plan on removing 8% to live on, letting whatever gains there are above this continue to compound and protect us from inflation.

Simply written, it looks like this.

We need $40,000 per year so our base amount needs to be $40,000 / .08 = $500,000.

If we have 500,000 and get 8% gain per year, we can remove 40,000 each year and still have the $500,000. Make sense? I hope so. You can see that if we make 10% instead of 8%, the $500,000 will actually increase in value. But some years it may make only 5%. We can still take our regular amount out, knowing that it will likely balance out and actually grow.

Start figuring out what you need now! Get a game plan! If you are in your 30′s, you have plenty of time, if you start now. Read How to Make a Million Dollars. If you are older, you may have to work longer than you wanted to, or adjust what you actually “need” to retire.

EDIT: Here is an excel sheet that gives an example, correcting for inflation, what it might look like. If we can get 12% average each year ( and I think that is entirely possible), then we can turn the original $500,000 into 1 million in only 25 years , and still take our 8% each year. A nice way to leave something for your kids!

As with all my financial or tax advice, I am not advising as a professional and I give no professional legal or tax advice. If you need professional advice, please get that from a CPA or attorney.

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5 comments to How Much Will I Need to Retire?

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  • Greg

    I think in your retirement calculator you have forgotten one very importatnt factor – inflation. You will not get a 8-10% return in a zero inflation world. If inflation is 3% then your $40,000 will need to be $41,200 in yr two. If your return is 8% and inflation is 3% then your withdrawal to not touch principal and keep up with inflation is 5%. (Technically it is not exaactly a straight subtraction but close enought to make the point). In that case to have $40,000 (and cover inflation for future withdrawals) you need $800,000 not $500,000. Quite a substantial difference.

  • Mack

    Greg, thanks for the comment and you make a very good point. Sometimes I assume things and I tend to overlook effects of inflation, ( even though I am very aware of it).. Inflation and the time value of money gets so many people confused that I think they sometimes just decide it’s all too complicated to understand. I want it to be simple. But you are correct and I need to change or re-write the post a bit.Actually, we need to get about 11% per year, ( if inflation is 3%) to keep up with inflation. A person would actually withdraw 8% of the balance in the account each year. So the actual withdrawal would be increasing each year, keeping up with inflation.I threw together a real dirty excel sheet to show this. You can download it from the link in the post above and see better what I am talking about. I still maintain that you only need the 500,000 dollars to return 40,000 a year, adjusted for inflation. The average return for growth stock mutuals over many many years is 12%. We only need 11% to make this work.Thanks again to Greg for pointing this out. He is right “on the money” on this. The bottom line is plan, plan, plan.

  • eb

    This is great, but what about years such as 2008, where large losses were posted?

    • Mack

      Eb, right, large losses are all around us right now, but some years there are large gains, much more than 12%… it is a planning tool. It depends on what you are invested in, and such. History confirms the 12%. Whether or not we get that in the future is anyone’s guess. I am sure people back in the 70′s would say the same thing, yet anyone who lived through the 70′s and 80′s knows what happened to the market.

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