How much do I need to retire: Retirement saving strategies

Saving for retirement is always challenging as there is no specific amount you need to save for retirement. The money you need to save before you can retire will depend on many factors which include life expectancy, your retirement age, and your monthly expenses. If you don’t save enough money for retirement you might risk outliving your savings which is the last thing you want to do. So, how much do you need to retire and what are the retirement saving strategies to reach your retirement saving goals?

You need to save enough so that you can live off interest from your investments without touching the principal. That is how much you need before you can retire comfortably. For example, if you are spending $50,000 per year, you will need $2,000,000 invested at more than 5%. If you are getting a 10% ROI, you will need to save at least $1,000,000. With this strategy, you will always live off your return on investment without touching the principal. What makes this retirement strategy great is that your risk of running out of money during retirement disappears because you never touch your principal.

While this retirement saving strategy is effective, not everyone is going to save 2 million dollars or more. Additionally, you don’t need that much money to retire. What is true is that the longer you stay alive after retirement, the more retirement savings you will need to sustain you for a while. Those who delay their retirement tend to need less savings as their active incomes continue to sustain them without touching their retirement savings.

This article will walk you through how much you need to retire and the best ways to save for retirement to make sure that you do not outlive your savings.

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How much do I need to retire?

If you are only interested in saving a particular amount, use the following retirement saving strategy. The money you will need before you retire will depend on these two important factors.

Life expectancy: How long you will live (the longer you live, the more money you will need)
Your retirement monthly expenses

With this strategy, I will assume that you are not going to have an active income to supplement your retirement distributions. You will only be living off what you saved in retirement accounts such as 401(k)s and IRAs, and your benefits from Social Security. Just a fixed amount you saved somewhere.

Let’s start by evaluating your life expectancy

According to Forbes, people who retire at 65 years old tend to live 20 years in retirement. However, those who retire around the age of 75 tend to live 12 more years. It looks like, your retirement date affects how long you stay alive during retirement. Keep in mind that some activities you do in your retirement can also affect your life expectancy. For example, people who eat healthy, drink enough water, stay active, and exercise, tend to live a little longer.

In this example, I will assume that you will retire at 65 years and live until 90 years old. This will give you around 25 years to live in retirement. The question is: How much money do you need to save to live comfortably for at least 25 years during retirement?

Next, let’s calculate your expected monthly expenses during retirement

Your retirement expenses play an important factor when calculating how much you need to retire. Although many people think that your expenses go higher during retirement, the truth might prove the opposite. According to Fidelity, younger people tend to spend more than people in retirement. Also, people who are between 55 and 65 tend to spend more. Households under 55 years old spend around $58,000 per year or $4,833 per month.

In this example, we will assume that you will be spending less money per month during retirement compared to younger people. So, let’s assume that you will be spending around $4,000 every month or $48,000 per year.

We now know that you will be spending $48,000 per year during retirement and you will live for 25 years. These two variables can easily help you calculate how much you will spend during your 25 years of retirement.

Since you will be spending $48,000 per year, you will spend $1,200,000 in 25 years. That is how much you need to retire assuming that all unexpected expenses are taken care of.

Keep in mind that we did not assume other factors such as emergencies, passive income, social security, and inflation.

Important: This retirement plan is not good due to external factors. If a life-threatening and costly event comes your way, your retirement plan will no longer work. For example, if you end up in a coma for 2 years and get a $200,000 bill; the amount you saved will not work.

That is why you focus on a retirement plan that is based on passive income rather than the total amount saved.

How much do I need to retire?

The money needed before anyone can retire varies from one person to another due to different lifestyles, retirement ages, life expectancy, and monthly expenses. An effective strategy most people use is to save a large amount that they cannot outlive.

How much can you save to never outlive your savings or have to work again during retirement?

Solution: Having a passive income that covers at least all your expenses is the safest way to never run out of money during retirement.

Instead of worrying about a specific amount you need to save for retirement, worry about how to generate enough passive income that cover your pre-determined expenses during retirement. This way, you will live off your passive income without touching your investments. That is how you retire.

Invest enough so that you can live off passive income without touching your principal

Many people worry about saving a specific amount for retirement. The downside of savings alone is that one simple life challenge can wipe out a big chunk of your retirement savings and mess up your retirement budget.

To solve this problem, you need to have investments with passive income that cover all your retirement expenses without touching the principal amount. This is like having a chicken that lays enough eggs you eat and never get hungry without having to eat the chicken.

Instead of asking, “How much do I need to retire?”, ask the following question: How much do I need to invest so that my passive income will cover all my retirement expenses? After finding the answer to this question, you will never worry about saving a specific amount for retirement.

Instead, you will worry about investing for retirement. The key here is that your rate of return from investments should be greater than your monthly expenses or retirement withdrawals.

For example, if you will be withdrawing 5% from your retirement account your passive income should be more than 5% after all deductions, charges, and fees are taken out. Having a much higher percentage return is way better as it prevents you from touching your principal.

Stick to the 4% retirement rule of thumb

When it comes to figuring out how much you need to retire, there are many rules and formulas you can use. These rules help people save and withdraw the right amount in ways that prolong their retirement savings. A common retirement rule of thumb is the 4% rule.

This rule helps retirees calculate how much they can withdraw from their retirement accounts without outliving their savings. According to Charles Schwab, you should withdraw only 4% of your total investment account and adjust your withdrawing percentages based on inflation rates for the following years.

This means that the amount you need to retire will be calculated based on your yearly withdrawals of 4%.

Before we apply the 4% rule, however, we need to know how much you will spend and your retirement income.

How much will you spend during retirement?

Although retirement expenses will vary from one person to another, there is a common expense percentage that most people fall into.

According to Fidelity, you should expect to spend between 55% and 80% of your final income before you retire. That is you will spend up to 80% of your final salary before retirement.

If your income before retirement was $120,000, you should expect to spend between $66,000(55%) and $96,000(80%) throughout your retirement. Knowing this value will be important when calculating your retirement income.

Let’s find out your retirement income.

Since you are expected to spend up to 80% of your final salary before retirement; you should have a retirement income that is at least 80% of your final income. This income can come from different sources such as passive income from investments, rental income, interest payments, dividends, and loyalty.

From the above example, you should make at least $96,000 per year which is 80% of $120,000. With this retirement income, you will cover all your expenses without running out of money.

Example of the 4% rule

From the example above, let’s assume that you will be making 80% of your annual income of $120,000. 80% of that salary will be $96,000. In order to make that $96,000 per year, you will need to have a portfolio of at least $2,400,000 ($96,000/4%). As long as you can withdraw 4% or less from this portfolio and your investments have an ROI that is at least higher than 4%, you will never run out of money.

When do I need to start saving for retirement?

The best time to start saving for retirement is NOW. Now is the perfect time to make your first retirement-saving contribution if you have not started 25 years ago. If you are close to your retirement, you should allocate most of your funds toward retirement. This is because you are running out of time. The only way to take full advantage of compound interest when you are close to retirement is to make large contributions.

If you are young, however, you don’t need to aggressively save for retirement. But, you need to get started now to allow compound interest to do its things. The sooner you start the better. What makes retirement saving fun is that you don’t need to save a large amount. Even if you can afford $50 a month, it will be enough to get started.

It is always easy to start early when saving for retirement. Start small, make your contributions, and repeat. Over time, the compounding formula will kick in. That is right. If you did not know it, the best way to build wealth is through compound interest.

How much income do I need to retire comfortably?

The income you need to retire comfortably depends on various factors such as your lifestyle, health, life expectancy, inflation rate, and cost of living in your preferred retirement location. On average, most retirement planning experts recommend having a retirement income that is about 70-80% of your pre-retirement salary.

This means if you are currently earning $100,000 per year, you should aim to have an annual retirement income of about $70,000 to $80,000. However, this is just a rule of thumb and your specific needs might be different.

Another strategy you can use to calculate your retirement income is to use the FIRE number. FIRE stands for financial independence retire early and it is a movement that has gained popularity in recent years. The FIRE formula suggests that you save 25 times the amount of annual expenses you anticipate having in retirement. For example, if you expect to spend $50,000 per year in retirement, according to this guideline you should aim to save $1.25 million.