Figuring out the “Magic Number” of what you need for retirement can seem like a daunting task that most people never try to take on themselves. If you’re wondering “how do I calculate what I need for retirement,” you’re in luck. This is where a CERTIFIED FINANCIAL PLANNER™ or financial advisor can be very beneficial.
How Do I Calculate What I Need For Retirement?
If you’re like me, you want to have a financial goal that you can work towards. If you’re looking for a general number to aim for, there is a relatively simple calculation to determine how much you need for retirement. All that’s required is basic math skills (add, subtract, multiple and divide) and a Time Value of Money (TVM) calculator, which you can download on your phone. I’ll walk you through this TMV calculation in 3 easy steps.
Step 1: Retirement Savings
Firstly, start out with what you’re going to need on a monthly basis if you were to retire today. This is where having a good budget comes into play. Below is a retirement budget worksheet. If you don’t have a working budget, this is a great personal finance item to have. It doesn’t take that much time either. Once you know that amount, subtract the items that you won’t have in retirement such as the money you are currently saving towards retirement.
In retirement, saving should be over. If you’ve done your part ahead of time and invested wisely, it’s time to spend that money. You also may have your house paid off. These are just a couple things you might need to subtract from your monthly expenses in retirement.
Step 2: Retirement Expenses
Take that monthly expense figure you came up with in Step 1 and multiply it by 12 to get the annual figure. Then enter that number into the “Present Value” in your TVM calculator. The Annual Rate or Interest (I) is going to be the inflation figure. This has historically been between 2.5-3% over time. The N or Periods is the number of years until you retire. If you’re 47 and plan on retiring at age 67, enter the number 20 for N or Periods. Make sure your calculator is set to annual compounding too.
So, let’s use Bob as the example. He currently has $5k in monthly expenses after he subtracts out his mortgage, which will be paid off, and his retirement savings that he’s currently adding to. This retirement savings is in the form of his 401k plan and Roth IRAs.
Here’s what Bob’s Calculator would look like:
- Present Value (PV): -60,000
- Payment (PMT): 0
- Future Value (FV): Solving
- Annual Rate (I): 2.5
- Periods (N): 20
The Future Value will come out to $98,317. This means that because of inflation over time Bob will need $98,317 each year to cover the same thing the $60,000 does today.
Step 3: The Magic Number
So, $98k is our annual number for year 1 of retirement. Let’s just round it off. This is finance not accounting. Now we can figure out what the total cost of retirement is. First, let’s understand that social security income in some form or another will be around. It will likely lower this number significantly based on how much Bob has contributed into the system over the years. Find out your Social Security Income Information.
Calculating What I Need For Retirement
Let’s assume Bob is going to get $30k a year in social security income starting at 67 years old. This lowers his annual income needed from savings to $68k in year 1. We then have to use $68,000 / 0.04 = $1,700,000. I used 4% because most studies show that, if you only take about 4% from your portfolio throughout retirement, you will likely not run out of money. This is assuming the account is properly invested. If you want to be more aggressive with your retirement withdrawals, you could change that to 5%. However, if you go much higher, you run the risk of running out of money in retirement.
How Much Do I Need To Save For Retirement?
These are the basic steps to finding out how much you need for retirement. Coming up with the “magic number” for retirement savings and investing isn’t that difficult. But, of course, there are many different variables that can come into play when calculating what you need for retirement. The example above is just a generic one to give you a better idea of how to come up with that number.
Walk through this exercise for yourself and think about the different variables that may come into play for your specific financial and investment situation. Also, use this helpful retirement savings calculator below in order to help manage savings for retirement.
Calculator for Retirement Savings