We get a kick out of the ING TV commercial, the one where one baby boomer asks another, “What’s your number”? The response, “a Gazillion”, always gets a laugh. But more importantly, the company makes a solid point – most people don’t have any idea how much they are going to need in retirement. It is a very important issue, because starting the day you retire, your life changes. You no longer have a salary that will pay the bills. Now you are on your own – you have to know if what you have saved and will receive from other sources will be enough to live on. If the “number” you have accumulated is too small, you might outlive your money. This article will try to help you get a better idea of how to calculate your number.
What is the Magic “Number
We interpret the number to mean how much you have to have accumulated in savings/investments to live a comfortable retirement. People often refer to it as the magic number that will let them quit working and start enjoying retirement. It’s just one of the related components of the financial picture, together with your pension (if any), social security, and working income. The latter items effect the size of your number, because the more income you get from these sources, the smaller your number has to be. But just as income plays a factor in this discussion, your expenses in retirement are equally important to how big your number has to be.
The bad news is that unless you will receive a good pension, your number is probably higher than you think.
The good news is that there are a number of tools and websites that will calculate your number for you (see list later in this article). Topretirements has other articles that will provide assistance in determining your financial needs, notably Ken Steiner’s article, “How Much Can I Spend in Retirement”, as well as “How to Retire in Style on a Budget“.
How to Determine Your Number
Like all good accounting issues, you start determining your number by figuring out the input and the output sides of the equation. Input is your retirement income. Output is what you are going to spend. You have control over both sides, although probably more control on how much you spend.
The major sources of your income will probably be:
– Pension or disability payments. For the lucky few a pension is an enormous benefit, often equivalent to millions of dollars of savings in its power to produce predictable income.
– Social Security. If you don’t already get an annual statement of projected benefits from the SSA, here is where you can request a statement. This report tells you what your monthly check will be, based on the age at which you retire and your previous earning history.
– Job or other income. If you choose to work in retirement, full or part time, and you can a get a job, you can significantly reduce your number.
– The number is the final component of the income side, but you can’t calculate it until you know your expenses.
As you might imagine, by the time you are at retirement age it is too late to affect most of these inputs, except for job income. You can usually keep working, find a new job, or start a new business. The only other item you can manage to some degree is when to start taking social security. If you can delay taking out money from the system until your “Full Retirement Age” (65-67 depending on when you were born), you will get significantly more money in your check each month. For example, if your full retirement age is 67 and you start taking benefits at 62, your benefits will be 25% less than if you waited until 67. If you wait until 70, you will get even more.
These typically include items like:
These are the items where you have some control. You can downsize, move to a more efficient house, sell your house and rent, rent a less expensive house, move to a less expensive state, or choose a more tax-friendly state. There are dozens of things you can do to lower your other expenses, which you might have to do if the input side of the equation isn’t high enough.
Now you are ready
Once you know your sources of income and your expenses, you can determine your number, the final component of the income side. Your number could be zero – if your other sources of income are enough to cover your expected expenses in retirement. But most people’s income sources (pensions, social security, job) don’t bring in enough to cover expected expenses, even though those typically go down in retirement. For most of us, our number has to be big enough to throw off enough income every year of retirement to pick up the slack. The number has to be able to do that year after year until the end of your life – unless you want to spend the last few years of your life in penury.
Calculating the right number is a complex question that is different for everyone. It depends on how old you are when you retire, how long you and your spouse will live, and the investment performance of your assets. Consulting a professional investment adviser is definitely recommended. But to get you started, there are many calculators that will give you a ballpark figure. A common rule of thumb is that you if you retire around 65 you can probably take out 3-6 % a year from your number, and not outlive your money. Obviously if you retire younger and/or your investment experience is worse than average, you will need a larger number.
Lets say that the Jones have calculated that their pensions, social security, and part-time income totals $36,000 a year. They estimate their retirement living expenses to be about $40,000 a year. The difference is a negative $4,000. Thus the Jones need an additional $4000 per year to maintain their expected retirement lifestyle. Their number is where will they make up the shortfall. So if they apply a 4% rule of thumb (some experts might recommend a little less or more), their number (total savings and investments) is $100,000 (= $4000 divided by .04). You can see from this illustration that it takes a huge number to generate meaningful yearly withdrawals, and this is the point where most people realize they should have saved a LOT more money. Even $1 million in savings doesn’t return that much, only $40,000 annually.
Most of the worksheets you will find online will help you develop your “number” by adding up the items on both sides of the ledger. You can do the same on a sheet of paper, thus creating a budget of what you think you will receive in income and have for expenses in retirement.
What do you think?
Have a different theory or experience? Topretirements visitors would be very happy to hear about it. Enter your thoughts in the Comments section below.
Your number is never absolute. It depends on how old you are when you stop working, how long you live, whether you take out more than you should, and what the investment performance of your savings is. If you make too many bad investments, you will be in trouble. Likewise if your assets return an unexpectedly high performance, you can live even better than you thought.