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How Much Money is Needed for Retirement

A difficult question that we are all grappling with is how much money will be needed for retirement.  As with most financial issues, it depends on your situation.  Some of the primary factors include your lifestyle and the expenses associated with that lifestyle, when you plan to retire, the asset allocation of your portfolio and your projected life expectancy.

To start understanding what is needed for retirement, develop a budget based on your current expenses.  Adjust your budget for expenses that will change in retirement such as 401k contributions, funding for college and mortgage payments.  You may have additional expenses in retirement for vacations, hobbies and medical expenses.  Most experts say you should plan to spend between 70% and 80% of your current expenses in retirement.

Retirement planning would be much easier if we knew our life expectancy.  Since this isn’t possible we need to make some projections.  If you are reasonably healthy and plan to retire near age 67, you have a good chance of spending at least 30 years in retirement.

When you are ready to get serious about how well you are positioned for retirement, I recommend meeting with a fee-only financial planner to run some projections based on your specific situation.  However, to get a very rough idea of how much you will need, consider using the 4% rule or some age based benchmarks.

The 4% rule was introduced by financial advisor Bill Bergen in 1994 and later made famous in a study by several professors at Trinity University.    It assumes you can withdraw up to 4% of your portfolio in the first year of retirement and 4% plus an adjustment for inflation each subsequent year, for up to 30 years. It’s based on an asset allocation of at least 60% in stock and 40% in interest earning investments. If you prefer a more conservative portfolio or anticipate spending more time in retirement, you should adjust the percentage down to 3 or 3.5%.  Additionally, some financial experts think 4% might be aggressive due to the recent low interest rates and lower projected stock market returns.

To calculate the amount needed in retirement using the 4% rule, subtract Social Security and other anticipated income from your projected retirement budget.  Divide this figure by .04 to arrive at an estimate of what you will need at retirement.  For example, if you need $50,000 per year after Social Security you will need a retirement nest egg of $1,250,000.

 Age based benchmarks can also provide a rough estimate of what will be needed at retirement.  Fidelity conducted a study on what you need to accumulate at different ages to retire at age 67.  They found that you need 3 times your income by age 40, 7 times your income by age 55 and 10 times your income by age 67.  The Fidelity analysis assumes an average lifetime asset allocation of at least 50% in stock.