By Jared Hoole
Friends and family often ask me how much savings they need in order to retire. While I am more than happy to talk in generalities, I try to steer away from giving any specifics when I don’t have all the facts. Without a complete view of their financial picture, it would not only be impossible but also irresponsible of me to answer their questions.
Unfortunately, more often than not, before I have a chance to respond, they hastily begin shouting out numbers. “Do I need half a million? One million?” Typically this leads to me awkwardly trying to explain that the solution isn’t that simple and ethically I really shouldn’t answer their question. This response is usually met with a bewildered look and the inevitable “So you’re saying that’s not enough?” (Heavy sigh) At this point, I coyly suggest that if they really want to know the answer they should become a client. (For related reading, see: 10 Habits of the Healthy, Wealthy & Wise.)
In an effort to provide friends and family with some guidance (and to quell the family banter), I have devised a quick back of the envelope calculation to give a ballpark estimate of how much savings one needs to retire. The calculation is rather easy to complete but does require some preliminary information before you can get started. I have included a list of the necessary data as well as a simple worksheet that will walk you through this approach. Please bear in mind that this is a rudimentary calculation that won’t give you an exact figure, but it can be used as a reality check to see if you are on target to retire comfortably.
Here’s what you will need:
To help illustrate the underlying methodology let’s consider the following scenario:
Now let’s work through the numbers:
On the bottom left of your paycheck should be a line that says “Net Pay.” This is your take-home pay after taxes, Social Security, Medicare and any other payroll deductions such as medical and retirement contributions.
Number of pay periods per year
Insert the number of pay periods per year. For example: weekly earners should list 52, semi-weekly earners should list 26, semi-monthly earners should list 24, etc. (Couples with different pay periods should do this exercise independently.)
Basic Annual Income Needs
This field is calculated by multiplying Line 1 and Line 2. This represents your basic annual income needs to cover your ordinary living expenses.
List the total federal tax from line 63 on page 2 of your 1040 plus any state taxes paid. Short-cut: If you don’t have your tax returns readily available multiply Line 3 by 20%.
List $ 6,500 if single or $ 13,000 if married unless you have a more accurate estimate of your medical expenses in retirement. This represents an estimate of Medicare Parts A, B, and D, a Medigap policy, and any out-of-pocket expenses.
Total Annual Income Needed
This field is calculated by adding Lines 3, 4 and 5 together. This represents the total annual income needed to cover all of your expenses.
Retirement Income (Social Security, Pension, etc.)
List your annual Social Security benefit, pension, part-time employment and any other guaranteed retirement income. Hint: if you are looking at your SSA statement be sure to multiply the monthly amount by 12.
Annual Income Needed from Savings
This field is calculated by subtracting Line 7 from Line 6. This represents the annual income you will need to draw from your savings to supplement your other retirement income.
Insert 20 if you anticipate a normal retirement period (30 years).
Insert 15 if you anticipate a shorter than normal retirement period (15 years).
Insert 22 if you anticipate a longer than normal retirement period (45 years).
This field is calculated by multiplying Line 8 and Line 9. It represents the total retirement savings required to maintain your standard of living in retirement.
Based on the chart above, Jack and Diane would need about $ 1.5 million to retire.
While I hope that you find the above exercise helpful, please keep in mind that it is a static calculation which doesn’t take into account life changes that may occur in retirement. To get a more precise calculation or recommendation, I would encourage you to reach out to a qualified financial advisor. (For more from this author, see: Don’t Let Sequential Risk Ruin Retirement Plans.)
*Multiplier is based on a success rate of 90% or more for a 15, 30 and 45-year portfolio. The calculations were completed by William P. Bengen, CFP® and can be found in his book “Conserving Client Portfolios During Retirement.”
**Note: the Savings Required field is not specific in nature and does not take into account your individual facts and circumstances. Accordingly, this should not be relied upon when determining how much money you need to retire, nor does it substitute for any legal, financial, tax, or accounting advice.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.