KJ: One of the commercials that Fidelity had running a few years ago had a green arrow with a number above each person. The magic number was the amount of money that person needed to have socked away for retirement. But, how did they calculate how much a person needs for retirement? What factors should you think about as your family plans for your future? Well, there have been numerous research studies over the years about a little thing called the ‘safe withdrawal rate.’ This is the percentage of your savings/investments that you could “reasonably” expect to withdraw over a long period of time while letting your savings continue to grow. I.e., it is the amount of income you and your family could plan to live off of in retirement. And, this is such a little understood concept of personal finance that it’s why people who win the lotto or sports players with HUGE signing contracts end up dead broke after spending all of their money.
And, if you do not have a barometer for what amount you need to save in order to retire, there’s slim chance that you can get there successfully. Do you need to have $500,000, $1,000,000, or $5,000,000+? The answer: it depends.
Looking at the math
While it is entirely dependent on your age in retirement, expense levels, and other factors, some suggest the safe withdrawal rate is anywhere between 3.5% and 4.5% of your savings. To illustrate this point, if you and your family had annual living expenses of $50,000 per year, you may need anywhere from $1,100,000 – $1,450,000 ($1,100,000 X 0.045 = $50,000) in savings to be able to maintain the purchasing power of your dollars over time while you took your $50,000 per year out of the account. I.e., in a “normal” year (whatever that is!) you could earn some return on your money, take your money out for your living expenses, yet still end up with the same amount of money as you started the year (accounting for the little thing called inflation, that is).
Fortunately, there are income sources like Social Security that may help reduce the overall amount you need to save, so the true amount you may need to accumulate in your savings could be MUCH lower. So, are you on track? One of our prior posts highlighted the milestones you could aim for based on your salary and age. Check it out here.
Other things to consider as you plan:
What does retirement mean after all? – Is it living on a beach, traveling around to play golf at all of the amazing courses around the world, or spending time at home with your family? Each of these has very different implications for what you would need to save and how your savings may need to keep up with your expenses. Thinking about it before-hand means you won’t be spending your days at home stuck to the computer wondering what you’re supposed to be doing with your time!
Expanding life expectancies
Life expectancies are not decreasing, but in fact have continued to increase significantly over the past century, so planning ahead by thinking about how long your savings could last you for the next 20, 30, or 40 years could be the difference between a well laid plan and a complete flop.
Your comfort levels for investments
Who would have thought this would come into play, but it really is an important one – especially when planning for a VERY long time horizon! If you’re not comfortable taking on a certain level of investment risk, you may have to save up more than your friend by shooting closer to the 3.5% target instead of 4.5%, so you can remain more conservative with your savings. Whatever your preferences, talk to your significant other (and an advisor as well) to get a feel for what you are and are not comfortable with when talking about your savings. If you find the stress of stock markets keep you up at night, then maybe you could be more conservative in your strategy. However, with that approach, you may find yourself needing to set aside more savings each month. It’s a bit of a trade-off, but it’s important to discuss before you find yourself making a reactive decision later!
- How do you calculate what you are aiming for?
What do you do to determine how much money you need for retirement?
Tell us your retirement success plans.
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