There are a lot of sites that help you determine how much you need to save for retirement to maintain your lifestyle. I have never been comfortable with them because they usually don’t share the logic behind their calculation. So I came up with the following 3 easy steps to calculate my own retirement needs. It is important to note that these steps do not take into account all the little caveats that may be unique to your situation; however, the method does offer a good starting point for your retirement planning.
For example, let’s pretend my wife and I make $50,000 per year and save $15,000 a year for retirement. When we retire 30 years from now, we don’t need to save $15,000 a year anymore. Therefore, we only need $35,000 per year.
However we want to improve our lifestyle during retirement, so we are going to bump it up to $40,000 per year.
I need $40,000 per year TODAY
Now we have to adjust that $40,000 for inflation. For this example, we assume an average inflation rate of 3.5% per year (I know this is a big assumption). We accomplish this with the following formula:
Inflation Adjusted $ = Today’s $ * ((1 + inflation rate)^ Number of years to retirement)
Inflation Adjusted $ = $40,000 * (1.035 ^ 30)
Inflation Adjusted $ = $113,000 (rounded up)
I need $113,000 per year 30 years from now (inflation adjusted)
Retire Early suggested that the safe withdrawal rate is about 4% according to various studies (i.e., Bengen Study, Harvard Study, and Trinity Study). Now the formula:
Retirement Needs = Inflation Adjusted Income * 25
Retirement Needs = $2,825,000
I need to save $2.8 million to begin retirement