Now that we have discussed paying down your debt, lets jump right into the fun part! How much money do you need to retire exactly? Imagine having so much money sitting in the bank that you NO. LONGER. HAVE. TO. WORK. I fantasized about that day before I even really started working.
It may seem like a long way away, but the earlier you start to think about it the easier it is to create.
You will get older. I know it sucks to imagine, but it will happen.
(Seriously where did THAT laugh line come from…. maybe I should just stop laughing?)
There are a million suggested ways to calculate how much money you need to retire. Even worse, so many suggestions start with “It depends” (See my rant about that saying here).
I think it is actually pretty simple to estimate how much you will need. There, I said it.
First, lets go over an older way of calculating how much you will need for retirement.
Calculation I DON’T think you should use:
1. Needing 70-85% of your pre- retirement income (every year)
This one gets very confusing because it suggests requiring ~80% of the salary you made while working (yearly, for the rest of your life). My first complaint is that it is too easy to make a calculation mistake because the rule requires you to know the amount of years you will live after retiring.
Say you made $100,000 a year while you worked. This calculator suggests you would then need to save $80,000 for each year that you will be retired. What if you estimate that you will live for 20 years, but it turns out you had fantastic genetics on your grandma’s side that you did not know about. You accidentally live for 40 years, but run out of money.
Well, that math mistake just got awkward.
The main reason I disagree with this rule though is because it focuses on how much you EARN. From what I have seen though, the most important financial characteristic is how much you SPEND.
Lets create some characters to show my point. To make the math easier, let’s assume its a world without taxes.
Beth earned $100,000 a year while she worked. She lived a lavish lifestyle though, and spent $90,000 yearly. She never quite managed to pay off her house, so she’ll retire with mortgage payments. Beth has two kids that she is currently putting through university. Beth also wants to have an action packed retirement, so her bills will not be decreasing.
Tara also earned $100,000 yearly while working (it seems to be a popular number tonight). Tara managed her finances better, and is used to living on $50,000 yearly. She paid off her modest home years ago, so she forgets what a mortgage payment even feels like. Tara figures her bills may actually go down in retirement.
Do you see why I think rule #1 makes no logical sense?
Since the first rule only cared about income, it would suggest Beth and Tara will require the same amount of money for retirement! Without doing any math, you can quickly see that that’s going to cause financial problems because they have wildly different spending.
So, much money do you need to retire exactly?
The goal isn’t more money. The goal is living life on your terms.-Chris Brogan
The way I recommend calculating your retirement needs is based on how much you spend, not on how much you earn. The great news about that? The less you spend, the easier your retirement fund should be to achieve! You cannot always control your income (I empathize here), but you can control your spending.
Track your spending for awhile (actually write it down) and get a good idea of how much an average month costs you. Keep in mind once you’re retired you will hopefully no longer have mortgage payments, and you will no longer need to save for retirement (You made it!)[ Some money now or more money later?]
If you plan on adding things like travel to your life, estimate those costs and add them into your dream retirement fund.
Once you know your monthly costs, multiply it by 12 to calculate your yearly costs!
Yearly budget= Monthly budget x 12
How much cash do you need saved in order to never stress about retirement money running out? 25 times your yearly costs.
Why 25x my yearly costs?
Generally with investments, it is safe to withdrawal 4% yearly and never have to worry about your savings running out. (Understanding why 4% is safe is complex, so I will go over that by itself in a future article. If you want to learn more now, check out chapter 29 of this book and it will make complete sense).
Since you can safely withdrawal 4% each year without worrying about running out of money, we can flip the calculation to something easier to use:
How much you need to save for retirement= yearly spending / 4% safe withdrawal rate
How much you need to save for retirement = 25x yearly spending
This means that for every $4000 you want to spend yearly, you should have $100,000 saved. If you have one million in the bank, you can spend $40,000 yearly without a single concern of the money ever running out.
(Keep in mind depending on where you live and whether you get a pension, you likely won’t have to cover all retirement costs out of your savings.)
If one million in savings (or whatever your goal amount is) sounds like so much money your head explodes, don’t stress. We’re going to discuss tons of strategies on this blog to reduce your spending, and improve your savings. I believe one million is highly possible for most people to save during their lifetime, even if you don’t have an extraordinary income!
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