How Much Money Do You Need to Retire?

A slim majority of Americans typically retire between the ages of 61 and 65, according to statistics from the U.S. Census Bureau from several years ago. Another 12% retire a little later, between 66 and 69.

While delaying retirement into one's 70s or later is less common, it certainly does happen. About 14% of workers retire between 70 and 79, while 7% of Americans wait until their 80s and beyond to leave the labor force.

Still, a sizable number of Americans do the opposite, retiring early instead of late. About 17% of labor force participants stop working between ages 50 and 60, while about 1% retire even earlier than that.

What motivates people to retire at the ages they do?

Image source: Getty Images.

Retirement isn't an age -- it's a dollar amount

For most, it's a financial decision. Workers who delay retirement, for instance, do so because they have to -- they simply lack the savings necessary to retire earlier. In fact, a survey from the Bank of Montreal (BMO -1.71%) indicates that a quarter of Americans plan to delay retirement because rising costs are forcing them to spend more now and hampering their ability to stash away enough for old age.

On the flip side, retirees who leave the workforce early do so because they can. While most retirees cite health concerns as the main reason for premature retirement, what ultimately enables them to stop working is their financial situation -- they've saved up enough to sustain the lifestyles they want even in the absence of further income from employment.

But what exactly is "enough"? How much money do you need to retire?

Determining and calculating how much you need in retirement

It's common knowledge that you need to save and invest for retirement. But determining the size of the nest egg you'll need is a bit more difficult. After all, if you're willing to live frugally in retirement, you may do fine with $1 million in savings. On the other hand, if you want a more lavish lifestyle in your golden years, you may need several million -- or even more.

Luckily, there are a few rules of thumb that can help you approximate how much you'll need to have saved to retire.

To arrive at your retirement "number," begin with your current (individual or household) income. To maintain a post-retirement standard of living on par with your current lifestyle, you'll need a nest egg that can reliably generate enough passive, non-employment income per year to replace about 75% of that.

One big reason why you won't need to replace 100% of your current income is that you'll no longer need to save any portion of your income for retirement once you're in retirement. Once you're retired, you'll be drawing down (spending) your assets rather than accumulating (saving) them.

Additionally, unlike income from employment, pension income, Social Security payments, and withdrawals from retirement accounts such as 401(k)s or IRAs aren't subject to federal payroll (FICA) taxes, which typically total 7.65% of earnings.

Note that you'll still owe federal and state income taxes on most of your retirement income, other than withdrawals from Roth accounts or income from securities such as tax-exempt municipal bonds.

For example, suppose that you're an attorney making $125,000 a year now. Your spouse is an accountant who makes $75,000 annually. Together, you have a household income of $200,000. To retire, your combined retirement nest egg will need to reliably generate roughly 75% of that amount, or about $150,000 per year.

Portfolio withdrawal rates

But what does "reliably" mean? In 1994, financial advisor Bill Bengen created the now-famous 4% rule. Also known as the "safe withdrawal rate" (SWR), it asserted that if a retiree withdraws 4% of the initial balance of their portfolio each year, adjusted for inflation, they should be able to keep up that pattern for at least 30 years before the well runs dry. Following that guideline gives a person a good chance of not running out of money in their golden years.

Nonetheless, the 4% rule is not perfect. For starters, it only assumes a 30-year retirement, so if you retire early, live an exceptionally long life, or hold an overly conservative balance of assets in your portfolio, you run the risk of depleting your assets prematurely.

Additionally, the safe withdrawal rate presumes that you'll be fine with spending down your principal in retirement. This may not be an issue for you if you're comfortable with the idea of drawing down most or all of your wealth by the end of your life. However, if you want to leave money to heirs or charity, you may want to consider a more conservative withdrawal strategy -- like the perpetual withdrawal rate (PWR), for instance.

Unlike the SWR, the PWR limits withdrawals to the earnings (e.g., interest, dividends, rent, etc.) generated by your nest egg, leaving the inflation-adjusted principal balance of your savings intact. In other words, the PWR is the rate at which you can spend in retirement without ever running out of money.

Naturally, the PWR will always be lower than the SWR -- but not by much. For time horizons exceeding 40 or 50 years, the PWR for a balanced portfolio of 50% broad market equities (like Vanguard's Total Stock Market Index Fund ETF) (VTI -0.30%) and 50% bonds hovers between 3% and 3.5%.

Put differently, our nurse and attorney couple will need about $3.75 million to generate $150,000 a year in income at a 4% safe withdrawal rate, and about $4.28 million (or $5 million) to produce the same amount of income at a 3.5% (or 3%) perpetual withdrawal rate.

What if you're targeting a different amount of income in retirement? Let's see what you'll need to have saved up at varying withdrawal rates.

Calculations by author.

In brief, you'll almost certainly need $1 million or more to retire. But if you're a big spender -- or want to opt for the PWR over the SWR -- you'll probably need even more in the bank before you can safely call it quits.