Determine Your Retirement Needs In 3 Easy Steps

By Pinyo, on September 24, 2007

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.
Calculator
Photo from stock.xchng

Step 1: How much do I need today?

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

Step 2: Adjust for inflation.

Now we have to adjust that $40,000 for inflation. For this example, we assume inflation rate is 3.5% per year. 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 after inflation

Step 3: Multiply by 25

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

Several things to consider:

This assumes retirement age of 65. I haven’t explored other variables. This is just a quick estimate.
This doesn’t say anything about how to get to the number in step 3. I plan to cover that in a future post.
I didn’t take into account expected annual Social Security payment or Pension payment. As such, if you have money coming from these sources, you can lower the calculated number in step 2.

More on retirement investing and planning:

Financial Dominance, What is the 4% Rule?
WM Financial Services, How Much Will You Need for Retirement?
CNN Money, How much will you need for retirement?
ING Retirement Plans, Determine Your Retirement Needs
MSN Money, How much do you need to retire?
Argonne Credit Union, How to Calculate Your Retirement Needs

This article was featured in the 120th Carnival of Personal Finance hosted by My Retirement Blog.

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Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

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7 Comments

Millionster
September 26, 2007, 0:50

Ah – I see retiring as a last resort – lol. So you know I half-heartedly put anything into my 401k… ^_^
Pinyo
September 26, 2007, 6:11

I am not sure what you mean.

For me, the only thing that would stop me from contributing to 401k is if it delays my retirement. For instance, if I can reach financial independence by age 45, but can’t access my money until 55 because it’s all in 401k — then I still have to work 10 more years.
Elaine
December 19, 2007, 13:23

I don’t see interest included in the calculations here. Even at 4%, *just the annual interest* on 1.8 million will cover your annual needs. Not that that’s a bad thing, you’ll still have 1.8 mil left when you die. If you plan to use up all your money in retirement the necessary amount would be quite a bit lower.
Pinyo
December 19, 2007, 16:14

@Elaine – Welcome to Moolanomy. No, I didn’t include it, nor mentioned that most people will have to invest for another 20 years during their retirement. I was just trying to keep it simple
Make Friends, Earn Money
May 30, 2008, 2:55

Many people forget to adjust for inflation and I’m glad you’ve pointed this out. That’s why final slary schemes are great because the adjustment is already made, but in private pension planning you definately need to do this.
AJC @ 7million7years
May 27, 2009, 17:52

@ Elaine – You earn 4% on your money and before you get to spend any of it, Mr Inflation ’spends’ 3.5% for you … can YOU live off just 0.5% of $1.8 Million?
CamKC
June 13, 2009, 19:37

I’ve done a spreadsheet and put it up on Google Docs at:

http://spreadsheets.google.com.....utput=html

There’s a column there headed “Factor” which makes the calculations a bit simpler.

So now you can find your retirement needs in one step.

Find the row with your number of years to retirement, grab the “factor” value, multiply it by the amount you want in the first year of retirement, and there you are.

For example, 35 years to retirement has factor 98.65, so if you want $70,000 then its:

98.65 * 70 000

If you want 50,000 then its:

98.65 * 50 000.

I hope this helps.

Click “CamKC” if you’d like to see my finance blog.

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