Cost to Retire - How Much Money Do You Need? (Part 1)

How much money do you need to save in order to retire? It’s a common question, especially as people are nearing that time and start to wonder if there’s an actual number they need to know to be comfortable. 

Elijah Heath, a CERTIFIED FINANCIAL PLANNER™ professional at Heath Wealth Management, has created two quick ways to answer this question. Why? Because he learned early in his career that people would stop him and regularly ask him about their retirement plans. He says, “I would tell them my team and I help all our clients answer the two questions that keep them up at night: 1) Am I going to make it on what I have saved for retirement? And 2) Do I have any blind spots?” 

THE FIRST STEP – DEFINE YOUR RETIREMENT

Before you can determine how much money you will need to retire, you first need to define what you want your retirement to look like. Start with ideas and goals you want for your retirement years. You can always change your plans later but thinking about what you want to do in retirement will help your financial planner look at your current financial situation and review where you want to be financially when you retire.  

What do you want your future to look like? No detail is too small if it’s important to you. For example, if you want to be able to travel once a year, spend time and money on a favorite hobby, or do volunteer work, think about the lifestyle you want to enjoy. Share this with your financial planner so they can create a roadmap to get you from where you are today, point A, to where you want to be in retirement, point B. 

A good planner will help you continuously review your plans, checking for any “blind spots” that could cause your plan to derail. What are “blind spots”? Serious health concerns, new home purchases, major repairs/renovations to an existing home, an unplanned vacation, or the death of one spouse whose income was greater than the other. 

That’s basically retirement planning 101. And the million-dollar question: Define what “it” is for you. 

COST TO RETIRE – FACTORS TO CONSIDER 

When you sit down with your financial planner, you will assess where you are – the starting point of your financial journey to retirement. Some of the next factors to consider:

  • How much income are you going to need? 

  • When and how long will you need income in retirement? 

  • What will inflation do to your purchasing power? 

  • How much risk are you comfortable taking with your retirement funds? 

  • What will tax laws and rates be when you retire?

How Much Income Are You Going To Need? 

That’s a tough question. The earlier you start saving means you can factor in compounding savings and investments. Time is your friend even when rates fluctuate over time. Your financial planner can show you how these compounding and interest rate numbers impact your retirement plan. 

They should also be looking for potential blind spots such as taxes, health care, and inflation. When it comes to health insurance, Medicare has gaps in it that you need to be prepared for. For example, Medicare covers rehabilitation stays, which is short-term care, but it doesn’t cover assisted living and nursing home care, which lasts much longer. Dementia or other long-term events are very expensive health care needs. Are you prepared to cover these? 

When And How Long Will You Need Income In Retirement? 

That’s a life expectancy question. Consider what age you plan to retire and understand you have no way to know at what age you will pass away. It’s possible for some people to live to be 100 years old so it’s important to plan long-term. Many people could spend 30-40 years on “unemployment” in their retirement.  

What Will Inflation Do To Your Purchasing Power?

Tomorrow’s dollars will be different from today’s dollars due to inflation. Your savings will lose purchasing power because of inflation, which means you will pay more for things than you do now. A good financial planner can help you make certain assumptions about what inflation will be and factor that increase into your financial retirement plan. For example, if you look at past inflation increases, the average is 2% – 3% per year. Health care costs rise an average of 5% a year. These are important factors to consider.  

How Much Risk Are You Comfortable Taking With Your Retirement Funds? 

Some people are more comfortable taking higher levels of risk with their investments than others. One option may be to start with higher risk and begin to lower risk to a more conservative approach as retirement approaches.  If you take too much risk, especially if you’re trying to “catch up” to years you weren’t saving for retirement, it’s possible to lose some of the money you have saved and gain nothing. 

TWO QUICK WAYS TO CALCULATE HOW MUCH MONEY YOU WILL NEED 

Let’s be honest – there’s a lot of work that goes into retirement planning. If you’re one of those people who think you don’t have enough time to sit down with an advisor to carefully review and discuss your financial plans, consider this: With the right plan in place, it’s possible to go into retirement and live comfortably with $100,000 saved. It’s also possible to think you’re safe with millions of dollars saved and run out of money before you die, depending on your lifestyle. It’s critical that you get and listen to good financial planning advice. 

#1 – QUICK RULE OF THUMB MATH

Elijah Heath, a CFP® professional, says he will sometimes run into people when he’s out of his office and they will ask him, “I need help with my retirement, but I don’t have time to go through all the planning. Can you just tell me how much I need to retire?” So he’s come up with a quick answer using this rule of thumb method: 

  1. He asks, “What is your income today? Most people will need 80% of what they earn now to live on in retirement.” Elijah says some people are shocked by that simple answer and insist they can live on much less. They’ll say, “I’m currently making $250,000/year but I can live on $20,000 a year in retirement.” His advice? 
  2. Try it. Before you retire try living on the income you think is sufficient for one year. Most people can’t do it. They’re used to certain lifestyle habits and having more free time in retirement means they do choose to do those activities more, not less. People often find ways to spend even more money once they retire than they did while they were working. Elijah recommends using this rule of thumb estimate of 80% of your current income as the amount of money you’ll need to live on in retirement. 

#2 – RETIREMENT CALCULATOR – USE A FACTOR OF .035

This method requires a little more math but is an effective way to get a quick sense of how much money you will need to retire. Calculate your withdrawal rate from the amount of money you have saved using a factor of .035 (3.5%). 

Here’s an example: You’ve saved $100,000 and realize you need to retire now for health reasons. You’re out of time to save any more money while working. Do you want to know how much money you can expect to withdraw every year to live on? Using the .035 withdrawal rate, $100,000 x .035 means you could only withdraw $3,500/year. Can you live off that? Almost no one could live on that amount unless you have a pension or other income to supplement it. 

Another example: Let’s say you have saved $500,000 for retirement. That sounds like a nice amount of money saved, doesn’t it? When you do the math using the .035 withdrawal rate, $500,000 x .035 means you’ll be able to take $17,500/year from that half-million dollars. If you have no pension to add to that and need to wait a few more years for social security to come in, can you live on $17,500/year? While it’s possible to adjust that .035 rate higher to withdraw more money annually from your retirement savings, it increases the odds you will run out of money before you pass away. 

One last example: Let’s say you make $100,000 a year and using the 80% rule of thumb method above, you’re going to live on $80,000/year in retirement. Let’s also factor in that you have $25,000/year coming in from a pension and Social Security, so $80,000 minus $25,000 means you need $55,000/year from your retirement savings. Using the .035 factor to determine a withdrawal rate, this means you need $1.6 million to retire. This explanation often leads people to become upset when they hear the numbers because they thought they were ready to retire but haven’t saved up $1.6 million. 

In order to retire and live on your investments and savings, you must plan for your retirement and plan early. It helps to work with an experienced financial planner to put a retirement plan together so you can look at all the possible factors and create something that will work for you. 

In Part 2 of our discussion on how much money you need to save for retirement, we’ll look at some other scenarios if you’ve put off planning too long, had unexpected expenses occur such as health issues, and look at the results of compounding interest when you begin saving early for your retirement. 

We’re Here To Help You 

Elijah Heath, a CERTIFIED FINANCIAL PLANNER™ professional, is a *fiduciary with an ethical obligation to provide information, products, and services in your best interest, not what earns him the best fee or commission. Heath Wealth Management wants to be your advisor for life so you, your children, and your grandchildren all benefit from the relationship.

Call us to learn more, ask questions about your specific circumstances, and determine if we are the right fit for you. Our phone number is 813-556-7171. We can also be reached by email at Elijah.Heath@LPL.com.

*Fiduciary services are for advisory relationships only.