How Much Do You Need to Retire?

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

“How much do I need to retire?”

As Certified Financial Planners, this is probably one of the most common questions we hear from individuals who are approaching retirement. It is also one of the most difficult retirement questions to answer with a simple number.

You have probably heard some of the popular rules of thumb. You need $1 million to retire. Or maybe $2 million. Perhaps you have heard that you need to save 10 times your salary or accumulate enough investments to replace a certain percentage of your pre-retirement income.

While these retirement savings benchmarks can provide a starting point, they can also be misleading. From our experience building financial plans for individuals and families, there simply is not one retirement savings number that works for everyone.

One person may be able to retire comfortably with $400,000. Another household may need $1 million. Someone else may need $5 million or more to maintain the lifestyle they want.

Why is there such a big difference?

When determining how much money you need to retire, two variables tend to have an enormous impact:

• How much you expect to spend each year in retirement

• How much recurring income you expect to receive from Social Security, pensions, employment, and other sources

Once you understand those two numbers, you can begin estimating how much your investment portfolio may need to provide throughout retirement.

How Much Will You Spend in Retirement?

Before asking, “How much money do I need to retire?” we believe there is another question that needs to be answered first:

How much will you actually spend each year after you retire?

When we prepare financial plans for clients, we often go through retirement expenses line by line. That means looking beyond the big expenses and accounting for everything from property taxes and groceries to vacations, utilities, car insurance, home repairs, medical insurance, gifts, and entertainment.

Why get that detailed?

Because it is surprisingly easy to overlook smaller expenses. Forget one $500 monthly expense and it may not seem significant. Forget five or six of them, however, and suddenly your retirement spending estimate could be thousands of dollars per year below what you will actually need.

Retirement planning becomes much more useful when it is built around how you actually expect to live rather than a generic percentage of your current salary.

Your Expenses May Change After You Retire

Another important consideration is that your spending at age 65 may look very different from your spending at age 55.

Some expenses may decrease. If your children have moved out of the house, your grocery bill may be lower. Your mortgage may be paid off. You will no longer be contributing to a 401(k), and expenses associated with commuting to work may disappear.

Other expenses could increase.

Many new retirees spend more on travel, hobbies, entertainment, and dining because they finally have the time to enjoy them. Healthcare costs can also become a larger part of the household budget as retirement progresses. If you plan to relocate, downsize, purchase a second home, or make major improvements to your existing home, your housing expenses could change significantly as well.

This is why we generally want to know a household's expected after-tax annual spending when evaluating whether they have enough money to retire.

The relationship is fairly straightforward: the more you plan to spend, the more income your retirement plan needs to produce and, all else being equal, the more assets you will generally need.

Don't Forget About Inflation in Retirement

One of the biggest mistakes you can make when estimating how much you need for retirement is assuming today's expenses will remain unchanged.

They won't.

The price of groceries, utilities, insurance, healthcare, travel, and most other goods and services tends to rise over time. For planning purposes, assume that a household currently needs $80,000 per year after taxes and we model those expenses increasing by 3% annually.

After 10 years, that household would need approximately $107,500 per year to purchase what $80,000 buys today.

After 20 years, the number would be approximately $144,500 per year.

Nothing about the family's lifestyle necessarily changed. They may be buying essentially the same goods and services. Inflation simply increased the number of dollars required to maintain that lifestyle.  This becomes especially important because retirement can last 20, 30, or even 40 years. A retirement plan that works at age 65 based on today's expenses may not necessarily work at age 85 unless inflation has been incorporated into the projections.

It is also important to recognize that inflation does not occur at exactly 3% every year. Some years will be higher and some will be lower. A 3% assumption is simply an example of how inflation can be modeled in a long-term financial plan.

Pensions Can Dramatically Change How Much You Need to Retire

Once you have estimated your expenses, the second major part of the equation is determining your retirement income.  This is where two households with identical lifestyles can require dramatically different amounts of retirement savings.

Some retirees are fortunate enough to have a pension through a former employer. This is still relatively common among certain teachers, state and local government employees, and workers who spent their careers with employers that maintained traditional pension plans.

For example, assume someone expects to receive a $50,000 annual pension for life. That $50,000 of recurring income can substantially reduce the amount that needs to be generated from 401(k)s, IRAs, brokerage accounts, and other investments.

Compare that with someone who has the exact same annual expenses but no pension. That person's investment portfolio may have to produce substantially more income every year.

This is one reason why asking whether $1 million is “enough” to retire does not provide enough information to answer the question.  For one household, $1 million combined with a significant pension may provide more than enough resources to support its desired lifestyle. For another household without a pension and with higher spending needs, $1 million may be insufficient.

Social Security Is Another Important Retirement Income Source

For many retirees, Social Security represents another important source of recurring retirement income.  Depending on when you retire and when you claim Social Security, those two dates may not be the same. Someone could retire from work at age 62 but decide to wait several years before beginning Social Security. That creates a temporary period in which investments or other income sources may need to cover more of the household's expenses.

Social Security also has an important inflation-related feature. Benefits generally receive annual cost-of-living adjustments, or COLAs, when the applicable inflation measure increases. Those adjustments are intended to help protect the purchasing power of Social Security benefits over time. That can make Social Security different from a pension that does not include a cost-of-living adjustment. A fixed $40,000 pension may feel substantial at the beginning of retirement, but its purchasing power can gradually decline as prices increase.

For this reason, it is important to know not only how much pension income you will receive, but also whether the pension includes an inflation adjustment.

An Example: Susan Retires With a Pension

Let's look at a hypothetical example. 

Assume Susan is preparing to retire and expects to spend $70,000 per year after taxes. 

Susan was a teacher and expects to receive a pension of approximately $40,000 per year. She also expects to receive approximately $25,000 per year from Social Security once she begins collecting benefits.

At first glance, you might add the two numbers together:

$40,000 pension + $25,000 Social Security = $65,000 of annual income.

Since Susan spends $70,000, you might conclude that she only needs to withdraw another $5,000 from her investments.

But there is an important issue missing from that calculation:

Taxes.

Retirement Income and Retirement Spending Are Not the Same Number

When we talk about retirement expenses, we are generally interested in the dollars available to actually pay those expenses.

If Susan needs $70,000 deposited into her checking account during the year to support her lifestyle, she may need more than $70,000 of gross income to produce that amount after federal and potentially state income taxes.

Pension payments can be fully or partially taxable depending on the pension and the participant's basis in the plan. Social Security benefits may also be partially taxable depending on the retiree's overall income. Distributions from traditional IRAs, 401(k)s, and similar pre-tax retirement accounts are generally subject to ordinary income tax, while qualified Roth distributions can receive different tax treatment.

For that reason, simply adding your pension, Social Security, and retirement account withdrawals together without accounting for taxes can significantly distort your retirement projection.

Suppose Susan needs approximately $80,000 of gross income to produce her desired $70,000 of spendable income. The exact amount would depend on her tax situation, deductions, account types, state of residence, and other factors, but the example illustrates why taxes need to be incorporated into the retirement plan.

Now Compare Susan With Scott

Let's compare Susan with another hypothetical retiree named Scott.

Scott also wants $70,000 per year after taxes to support his retirement lifestyle.

Like Susan, Scott expects approximately $25,000 per year from Social Security. However, unlike Susan, Scott does not have a pension.

That difference is significant.

Susan has $40,000 of additional recurring pension income helping to support her lifestyle every year. Scott has to replace that missing income from somewhere else, which will most likely mean taking larger withdrawals from his 401(k), IRA, brokerage account, or other investments.

Even though Susan and Scott want exactly the same lifestyle and have the same annual expenses, Scott may need substantially more retirement assets than Susan. This illustrates why there is no universal answer to the question, “How much money do I need to retire?”  Your required retirement savings are determined by the gap between what you plan to spend and the reliable income sources available to help pay those expenses.

Think About Your Retirement Income Gap

One useful way to begin thinking about retirement is to calculate your retirement income gap.

For example, imagine a household needs $100,000 per year of gross income to support its lifestyle and taxes.  If Social Security and pensions provide $70,000 per year, the household has approximately a $30,000 annual income gap that needs to be filled by investments or other sources.

Now consider another household with the exact same $100,000 income requirement but only $30,000 of Social Security and no pension. That household has approximately a $70,000 annual income gap.  Those two households may need very different amounts saved for retirement even though they maintain exactly the same standard of living.

Importantly, you cannot simply multiply the income gap by the number of years you expect to live. A comprehensive retirement projection should consider investment returns, inflation, taxes, the timing of withdrawals, the types of accounts being used, and how long the assets may need to last.

Part-Time Work Can Reduce the Amount You Need From Investments

Part-time income is also becoming an increasingly important part of retirement planning.

Not everyone wants to stop working completely on the day they retire from their primary career. Someone might leave a full-time position at age 60 and continue consulting, teaching, working seasonally, or pursuing another part-time job for the next five or ten years.  That income can have a meaningful impact on a retirement plan.

Assume someone retires at age 60 and earns $30,000 per year from part-time work until age 67. Those earnings could reduce the amount that needs to be withdrawn from investments during the first seven years of retirement.  That can be particularly valuable because the early years of retirement can be a sensitive period for an investment portfolio. Reducing withdrawals may allow more of the portfolio to remain invested and potentially continue growing.

Part-time income can also serve as a bridge between the date you retire and the date you begin Social Security, a pension, or other retirement benefits.

What About an Inheritance?

Expected inheritances may also factor into a long-term financial plan, but they should generally be approached cautiously.  For example, an individual may have parents with substantial assets who are spending considerably less than their retirement accounts and other investments are generating. It may appear likely that some of those assets will eventually pass to their children.

However, there are significant uncertainties associated with an inheritance. The timing is unknown. The amount can change. Parents may encounter substantial healthcare or long-term-care expenses, investment values may fluctuate, estate plans can change, and other unexpected events can occur.  For that reason, an inheritance can be incorporated into financial planning scenarios when appropriate, but it may make sense to also evaluate whether the retirement plan works without relying heavily on that future inheritance.

If the plan succeeds without the inheritance, the eventual inheritance may simply create additional financial flexibility later.

So, How Much Do You Actually Need to Retire?

This brings us back to the original question.

Is $500,000 enough to retire?

Is $1 million enough?

Do you need $2 million?

The answer depends on your individual financial picture.  Someone spending $60,000 per year who receives a substantial pension and Social Security may require far fewer investment assets than someone spending $150,000 per year who has no pension.  Instead of beginning with an arbitrary retirement savings target, we generally believe the more useful approach is to work through the retirement equation in the opposite direction.

First, estimate how much you expect to spend after taxes each year. Then account for inflation and changes in expenses throughout retirement. Next, identify your expected income from Social Security, pensions, part-time work, rental properties, and other recurring sources. Determine how much of the remaining need must be supported by your investment portfolio.

From there, a retirement projection can evaluate whether your 401(k)s, 403(b)s, 457 plans, IRAs, Roth IRAs, brokerage accounts, cash, and other assets appear capable of supporting those withdrawals over your expected retirement.

That analysis should also account for taxes, investment returns, inflation, healthcare expenses, changes in income sources, and the possibility of living longer than expected.

Retirement Planning Is About More Than Reaching a Number

The question “How much do I need to retire?” sounds as though it should have a simple numerical answer.  But retirement planning is not really about reaching one magic account balance.  It is about determining whether the resources you have accumulated can reliably support the lifestyle you want for the rest of your life.

Two people can retire on the same day with the same amount in their 401(k)s and have completely different financial outcomes because their expenses, pensions, Social Security benefits, taxes, investment allocations, and retirement goals are different.

That is why detailed retirement planning can be so valuable. Instead of relying on a generic benchmark, a financial plan allows you to test your actual numbers and answer more useful questions: What happens if you retire two years earlier? What if inflation is higher? What if you delay Social Security? What happens if you spend more on travel during your first ten years of retirement? What if the market declines shortly after you retire?

Ultimately, the amount you need to retire is the amount required to support your retirement—not someone else's.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions About How Much You Need to Retire

1. How much money do I need to retire comfortably?
   There is no single amount that everyone needs to retire comfortably. The answer depends heavily on your annual spending, Social Security benefits, pension income, taxes, retirement age, investment portfolio, and how long your retirement assets may need to last. Someone with modest expenses and a large pension could potentially retire with substantially fewer investments than someone with high expenses and no pension. A retirement projection based on your expected cash flows provides a more useful answer than a generic savings target.
2. Is $1 million enough to retire?
   For some retirees, $1 million may be more than enough, while for others it may not be enough. If you have $1 million saved, low annual expenses, Social Security, and a substantial pension, your retirement income gap may be relatively small. If you have the same $1 million but spend significantly more each year and have no pension, your portfolio may need to support much larger withdrawals. Whether $1 million is enough to retire depends on the income that your investments need to replace.
3. Is $500,000 enough to retire?
   It can be, depending on your circumstances. A retiree with $500,000 who receives a pension and Social Security and has relatively low expenses may have a very different retirement outlook from someone with $500,000 who needs their portfolio to provide most of their income. Retirement age is also important because retiring earlier generally means your assets need to support a longer retirement.
4. How do I calculate how much I need to retire?
   Start by estimating your annual retirement expenses after taxes. Next, identify expected recurring income sources such as Social Security, pensions, rental income, and part-time employment. The difference between your spending needs and recurring income represents the amount that generally must be supported by your savings and investments. A comprehensive calculation should then incorporate inflation, taxes, expected investment returns, account types, retirement age, and longevity rather than simply multiplying the annual shortfall by a fixed number of years.
5. How much should I budget for expenses in retirement?
   A retirement budget should reflect the lifestyle you actually expect to maintain rather than relying exclusively on a percentage of your current salary. Review housing, property taxes, food, utilities, insurance, transportation, healthcare, travel, entertainment, gifts, home maintenance, and other recurring expenses. Also account for expenses that may disappear after retirement and expenses that could increase. Building a detailed retirement budget is one of the most important steps in determining how much you need to save.
6. How does inflation affect how much money I need for retirement?
   Inflation increases the cost of maintaining your lifestyle over time. At a hypothetical 3% annual inflation rate, $80,000 of annual expenses today would grow to approximately $107,500 after 10 years and about $144,500 after 20 years. Because retirement can last several decades, even moderate inflation can substantially increase your future income needs. This is why retirement planning should generally model expenses increasing over time rather than remaining flat.
7. Do I need less money to retire if I have a pension?
   Generally, a pension can reduce the amount of income that needs to come from your investments. If two retirees have identical expenses but one receives a $50,000 annual pension and the other does not, the retiree without the pension may need to withdraw substantially more from retirement accounts each year. However, pension taxation, survivor benefits, and whether the pension has a cost-of-living adjustment should also be considered.
8. How does Social Security affect how much I need to save for retirement?
   Social Security can reduce the amount of annual income your investment portfolio needs to generate. The timing of your Social Security claim is also important because retiring before beginning benefits can create an income gap that needs to be funded from savings or other income. Social Security benefits can receive cost-of-living adjustments, which can help offset some of the impact of inflation over a long retirement.
9. Should taxes be included when calculating how much I need to retire?
   Yes. Taxes can have a significant impact on retirement cash flow. Withdrawals from traditional IRAs and many employer retirement plans are generally taxable, pension income may be fully or partially taxable, and a portion of Social Security benefits may be taxable depending on your income. Roth accounts and taxable brokerage accounts can have different tax treatment. Retirement planning should therefore focus on how much spendable, after-tax income you need rather than looking only at gross distributions.
10. What is the best way to determine if I have enough money to retire?
    A detailed retirement income projection can help determine whether your assets and expected income sources are sufficient to support your desired lifestyle. The analysis should incorporate your annual expenses, inflation, Social Security, pensions, investment accounts, taxes, expected returns, healthcare costs, retirement age, and longevity. It can also be helpful to test different scenarios, such as retiring earlier, delaying Social Security, experiencing lower investment returns, or increasing retirement spending. This provides a much more individualized answer than relying on a rule of thumb such as needing $1 million or $2 million to retire.