It’s a question anyone that’s serious about investing for retirement has asked themselves a thousand times: how much do I need to retire? Savers often want a direct, straightforward answer, like “You need $1,529,651 invested to retire.” Unfortunately, coming up with that number isn’t so easy. Before you try to determine your retirement number, there are a few different factors that come into play you need to understand.
Factors that affect your number
1. Expenses
How much you spend is the biggest factor in determining your retirement number. The more you spend, the more you need to have invested for retirement. If you are more frugal, you may be able to get by with less or retire early.
You can control your number by controlling how much you plan to spend in retirement, at least to a degree.
2. Inflation
Even if you are already retired, the true value, in today’s dollars, of your retirement distributions will decrease every year they experience inflation. The table below shows how much retirement distributions would be worth at different points in the future, assuming an annual inflation rate of 3%.
Unless you plan on spending less and less each year in retirement, you need to factor inflation into calculating your number.
3. Life expectancy
We are very fortunate to live in times where a long retirement is not just a hope, but often an expectation. Since 1900, the life expectancy in the U.S. has gone from 48 to 79. If you make it to age 65, you can expect to live even longer. At 65, men can expect to live to age 83 and women to 86. Someone retiring at 65 can expect to spend a couple decades in retirement, and possibly much longer if retiring early and/or living longer.
4. Taxes
Here’s a riddle for you: two individuals have the exact same amount invested for retirement, $5,000,000. They both take distributions of $200,000 annually in retirement. However, one is able to spend significantly more than the other. Why is this?
The answer is taxes. More specifically, the account structure of one portfolio is different from the other. An individual with $5,000,000 in a Roth account in retirement will have $5,000,000 to spend in retirement. Someone with $5,000,000 in a pre-tax account will not be able to spend all of that money in retirement. Depending on the state someone lives in, their effective tax rate on $200,000 of retirement income could be around 25% or a little more, based on current federal income tax rates. Out of that $5,000,000, they may only get to spend $3,750,000, or 75% of it. A higher income in retirement can also affect Medicare premiums and the taxation of Social Security benefits.
5. Other retirement income
All cash flow opportunities in retirement (pension, social security, and distributions from investment assets) should be considered when calculating your number.
Determining how much you need to have invested to retire is no easy task. There are many factors to consider when calculating your number, some of which you have no control over. We don’t know what inflation will look like in retirement, it’s impossible to know how long we will live, and while you can optimize your accounts in a tax-efficient way, it’s difficult to predict what tax rates will look like decades in the future.
Knowing your number isn’t about knowing everything, but about making informed, conservative estimates based on historical data, retirement goals, family history, and more.
Check out the video below for our discussion about how much you actually need to retire!
