Before you can retire, perhaps the most important thing you need to do is to make sure your financial needs will be met for the rest of your life. After all, the last thing you want is to run out of money and be forced to return to work when you're 75 or 80. While there's no one-size-fits-all way to come up with your "retirement number," by using a few simple rules of thumb, you can determine how much income you will need after retirement, and whether or not you have enough money to generate it.
How much income will you need?
Being able to retire comfortably isn't about how much money you have in the bank -- not entirely, anyway. Whether you'll be able to retire comfortably or not is a matter of being able to generate enough income to support your desired lifestyle.
There are several places where your retirement income can come from. Social Security is a big one, and you may also have a pension or other type of consistent retirement income from your job, or income from a part-time job you plan to have after retirement. The rest of your income need will need to come from your savings.
While it's not perfect, a general rule of thumb is that you will need 80% of your pre-retirement salary to sustain your lifestyle. Of course, this can be adjusted up or down depending on your desired lifestyle after retirement. If you plan to do a lot of traveling or engage in other costly pursuits, then you may need more than 80%. On the other hand, if you plan to live simply and spend less money than you did before you retired, you could probably get by on significantly less.
How much will come from Social Security?
The next piece of the puzzle is to figure out how much income you can expect from Social Security. Social Security is designed to replace roughly 40% of the average worker's income, but since the Social Security formula is heavily weighted toward lower-income workers, this percentage can vary significantly.
Your Social Security retirement benefit is based on your earnings throughout your career, as well as your age when you decide to start collecting benefits.
When calculating your retirement benefit, the Social Security Administration averages your earnings from the 35 years when you earned the most (adjusted for inflation). It then divides that average by 12 to find your average monthly earnings. This number is then applied to a formula that determines your primary insurance amount, or PIA, which is the Social Security retirement benefit you would be entitled to at your full retirement age.
Your full retirement age is between 66 and 67 years old, depending on the year you were born. People born before 1954 have a full retirement age of 66. Beginning with the 1955 birth year, two months will be added to the full retirement age each year until the full retirement age reaches 67 for people born in 1960 or later. If you retire before or after your full retirement age, your benefit will be permanently reduced or increased from the PIA.
The Social Security Administration provides a worksheet that can help you figure your benefit, but the easiest way is to create an account on the Social Security website, which will show you not only your estimated full retirement benefit amount, but also what your benefit would be if you retired at age 62 or 70, as well as some other important information.
Other sources of income
Once you have a good idea of what you can expect from Social Security, consider any other sources of income you expect to receive in retirement. These can include, but are not limited to:
- Any pensions you expect to receive from your current or former jobs.
- Income from any annuities you have purchased.
- Income from a part-time job you plan to work after retirement.
Calculating your retirement number
Once you've determined your expected Social Security benefit and considered any other sources of retirement income, you can calculate how much income you will need to generate from your own savings.
To determine how much income you will need from savings:
- First take your current pre-retirement salary and multiply it by 80%, or whatever percent of your preretirement income you feel you will need.
- Next, subtract the annual amounts you expect to receive from Social Security and any other sources of retirement income. This is the annual income you will need from your savings.
- Finally, since it's a good rule of thumb that you can expect to withdraw 4% of your retirement savings every year without fear of running out of money, multiply your savings income need by 25. This is how much of a nest egg you will need to safely provide the income you need throughout retirement.
Let's look at an example to illustrate this. We'll say that you and your spouse earn a combined income of $100,000. Using 80% of this amount as a guideline means that you will need $80,000 in annual income after retirement. After checking with the SSA, you find that you can expect a combined $35,000 per year from Social Security. You also have a pension from a former employer, from which you expect an additional $8,000 per year. Subtracting these amounts from your $80,000 income need shows that you will require $37,000 per year from savings.
Using our 4% rule, multiplying $37,000 by 25 gives you a retirement savings target of $925,000. This is the amount of money you would need in savings to produce $80,000 in total income during your first year of retirement and to comfortably give yourself cost-of-living increases in subsequent years.
Remember, this is just an estimate
As a final thought, bear in mind that this is just an estimate. Nobody can accurately predict what will happen with the economy, inflation, or your investments during your retirement. However, this is a good estimate, and a conservative one, so it's a good start to determine whether you have enough money saved to retire.