Are You Sure You Know How Much You'll Need for Retirement?

Source: Flickr / Ken Teegardin.

When it comes to retirement, a lot of investors have a specific number in mind that they would need to retire in complete comfort. What many people don't know is how to actually come up with an accurate estimate of how much money you'll actually need. Here's a quick guide to help you get started on your planning.

Estimate your annual expenses
You have probably heard of various estimates on how much of your previous income is needed to maintain a similar lifestyle in retirement, and around 75-85% seems to be the consensus. In other words, if your pre-retirement income is $100,000 per year, expect to draw around $75,000-$85,000 from your investments and other income sources.

However, this is not a one-size-fits-all formula. If you were a big saver in your working life, for instance, you are already used to living on a lower percentage of your salary. If you were paying a mortgage and your home is now paid off, that is an expense that no longer needs to be considered. So, it is very possible that the annual income you'll need in retirement is much lower than you think.

In your pre-retirement planning, it helps to try and eliminate as many expenses as possible before you retire (like a mortgage). Sit down and list all of your monthly expenses and consider how they might change once you retire. For example, if you have a long commute to work, you'll certainly be spending a lot less on gas!  Smaller expenses like that can really add up fast.

There have been studies that suggest that post-retirement expenses are not as much as experts think and that overall costs actually decline consistently after retiring. A recent study by the University of Michigan found that post-retirement spending is less than 60% of pre-retirement income, on average, so that is probably a more realistic goal to shoot for.

Don't count on help!
While your expenses may be less than you may think, one thing that you should not count on (especially if you are under 40) is Social Security. The SS program may indeed still be around, but likely at either a lower rate or higher retirement age. If Social Security does in fact still exist when you are ready to retire, it should be a bonus, not a core part of your plan.

The same can be said for employer-sponsored pensions. Pensions are an endangered species, especially in the private sector, and just like Social Security, benefit cuts and/or increased retirement ages are becoming the norm.

How you want to invest
The idea of equating the word "stocks" with "risk" in retirement is a flawed one. Not all stocks are risky and volatile any more than all corporate bonds are perfectly safe. Now, I would stay away from volatile tech companies, but dividend-paying blue chip stocks should always make up a substantial portion of any retirement portfolio.

Bonds can be great for income, but for retirement investors truly in it for the long haul, the concept of "total return" is what will keep your portfolio growing in perpetuity. The S&P 500, for example, has averages a total return (dividends and share price appreciation) of just under 10% since 1926.  Depending on the time period, an average of around 3-4% has come from dividend yields (income), with the rest coming from growth.

Is the "4% rule" right for everyone?
The short answer is "no", but it can be a good starting point. The "4% rule" of retirement essentially says that if you withdraw 4% of your retirement portfolio per year and increase your withdrawals with inflation, your account will last for as long as you do.

The 4% rule should work if you have a healthy mix of investments, specifically, at least half of your money in dividend-stocks that will allow your portfolio to appreciate over time. If you decide that you need $60,000 per year in retirement, your "number" would be $1,500,000. 

This amount could drop tremendously if you end up getting the same Social Security benefits that are around today or if you actually collect a pension in perpetuity, but as I said before, these situations should be thought of as a bonus, not as a core aspect of your retirement planning.

Nine great options for your income portfolio
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

Read/Post Comments (4) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 15, 2014, at 12:53 PM, kmiao1 wrote:

    I agree that you should be saving as much as you can and as early as you can, but the flip side of that is to cultivate a mind set of living below your means. Over time you will realize that you don't really need that much "stuff", and you can save more. I'm not advocating a deprived life style, not at all, but one of choices. Do you need a new car every 3 years? Why not every 6 years instead? Instead of buying garbage on sale, how about cultivating a sense of value and pay a little more for something that's higher value and turns out cheaper in the long run? And as you are saving you should be cultivating your mind to learn how to invest to make the savings compound like crazy. Before you know it, your savings are accumulating quickly and your break even point for a self sustaining financially independent existence gets that much closer. FIRE baby (Financial Independence, and Retire Early). Now retiring early is an option, but wouldn't you rather be in the driver's seat than always worried that you may be downsized?

  • Report this Comment On March 15, 2014, at 8:27 PM, nando wrote:

    Major unknown expense missing, Long term health care. Not everything is covered with Medicare and a suppliment is a MUST!

  • Report this Comment On March 16, 2014, at 10:50 AM, IrishJack32 wrote:

    Too bad, I spent 90% of my money on booze, babes, and gambling. The other 10% was spent foolishly.

  • Report this Comment On March 18, 2014, at 12:44 AM, toddgardner wrote:

    A lot of people are busy considering a lot of things when planning for retirement that they forget about one important thing, long term care. Due to longer life expectancy, people are more at risk of requiring assistance in carrying out their ADL's or activities of daily living. Statistics can back this up and according to

    and, 7 out of 10 people will require any form of long term care. If you have everything planned out such as your retirement spot, savings and activities, I suggest you should include long term care. The sad reality is this, ltc is real and it is expensive. Include this in your retirement planning in order to have a comfortable and enjoyable life in the latter part of your lives.

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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