How Much Do You Need for Retirement?

When it comes to personal finance, retiring in comfort is almost always the goal. But how much money do you need to retire? And how can you plan to get there?

There are lots of things that go into retirement that will effect how much you actually need. Luckily, a lot of smart people have already looked into this and done a lot of research to distill it down to a few easy-to-understand principles. If you search for information on this same question, you’ll see what’s called the 4% rule. The 4% rule centers on a concept known as your withdrawal rate. Your withdrawal rate is the percentage of your starting principal that you withdraw from your account for annual expenses. If you have $1 million for retirement and withdraw $100,000 each year, your withdrawal rate would be 10%. The 4% rule states that your withdrawal for the first year should be about 4% of your starting portfolio value. After that, you can continue to pull out the same amount of money each year (adjusting for inflation) without worrying about running out.

But just knowing the rule isn’t enough to plan your retirement (if it was this would be a pretty short article!). As with most rules, it’s not one-size-fits-all and you need to apply it to your personal situation. In order to know how to apply this rule, it’s important to understand how the rule came about.

The rule was originally proposed by financial planner William Bengen in 1994. His article, “Determining Withdrawal Rates Using Historical Data”, took a look at what the best withdrawal rate would be for an investment portfolio that would need to last for 30 years of retirement. He did this analysis for every 30 year period for which he had data, 1930–1960, 1931–1961, and so on. He found that at any point in history, a person could have had enough money for at least 30 years if they withdrew 4% of their starting principle in the first year and continued to withdraw the same amount after adjusting for inflation. At the worst time span in history, it would have taken 33 years to completely deplete your portfolio starting with a 4% withdrawal rate.

Another landmark study often cited is the Trinity Study. The study was published in the Journal of the American Association of Individual Investors under the title “Sustainable Withdrawal Rates From Your Retirement Portfolio”. This study, done by a few professors at Trinity University (hence the name), expanded upon Bengen’s analysis by looking at what they called portfolio success rates. Similar to Bengen, they looked at different withdrawal rates for various portfolios and how they would have performed in the past. But instead of looking for the minimum withdrawal rate that would guarantee a portfolio would last, they examined how often a portfolio would last. For example, while Bengen found that a 4% withdrawal rate would have lasted 30 year for any point in history, the Trinity Study found that if you increased your withdrawal rate to 5% (providing 20% more income during retirement), your money would have lasted 30 years 81% of the time.

It’s important to take note of the assumptions that these two studies took and see how you can apply them to your own situation. They assumed a portfolio of stocks and bonds where stocks constituted 50–75%. Both studies found that this range seems to be the optimal range for long term portfolio survival. The numbers I cited also assumed the money had to last 30 years. If you plan on retiring early, you’ll need more money to last you through retirement. Bengen found that if you withdrew 3% each year instead of 4%, your money would have lasted at least 50 years in all market conditions seen thus far. Withdrawing 1% less may sound like a great idea before realizing that that 1% actually means living on 25% less money during retirement.

So let’s see how this rule would work out for the average individual. Let’s say you’re 32, want to retire in 30 years, and you plan to have 30 years of retirement. You’d like to live a general middle class lifestyle in retirement which you think would cost about $60,000/year. If we’re following the 4% rule, some simple math tells us that our portfolio needs to be 25 times the value of our expenses. For $60,000, that’s a cool $1.5 million.

So now that we’ve all determined that we’re never going to have enough to retire, let’s take a step back and look at some more assumptions made by these studies. Or more accurately, the assumptions we were making. In applying the results of these studies, thus far we’ve assumed that all of our retirement income will be coming solely from our portfolios. For most retirees, that’s simply not going to be true. Those in the U.S. will (hopefully) have Social Security income to supplement their retirement. A 32 year old making $60,000 a year can expect to get about $1,471/month from Social Security. If we add this income into our equation, you need just over $1 million to retire in 30 years. You can estimate your own personal Social Security income by using the calculator on their website or signing up for a My Social Security account. That’s also not including any part time income you generate from jobs or hobbies.

Another piece that may not always be true is the assumption that withdrawals will remain constant after adjusting for inflation. In reality, spending will likely vary with the market conditions. If things are going well, spending may keep up with inflation or even go a little above that. If market conditions are bad, your spending is likely to decrease, at least a little. There’s also growing research, like that done at the Center for Retirement Research at Boston College, that suggests people start to spend less as they continue to age. The research suggests that spending generally decreases 1–2% each year after the first decade in retirement after accounting for inflation. If you’re like everybody else, you’ll also start to spend less as you continue to age in retirement.

So how do you take all of this information and actually apply it to your own situation? In order to plan for retirement, you need to decide on a few important factors. The first one is what kind of lifestyle do you plan on living in retirement? If you want a quiet life in the country side then you’ll likely have lower expenses than someone who is planning on traveling extensively. You should already have a budget for your current lifestyle and can use that to estimate your expenses in retirement.

Second, you need to determine how long your retirement will be. While nobody can tell you how long you’ll live, you can use the fact that the average American life expectancy is 78 years to estimate your own life span. This is likely to continue to go up in the future. Additionally, if you plan on retiring early, you’ll get to enjoy more years in retirement but it also means that your portfolio needs to last longer.

Finally, when determining how much you actually need, you should make all your plans after adjusting for inflation. Each of the studies and numbers above have been in terms of today’s dollars. But you’ll be saving for the future so knowing how much you need today doesn’t really help. You need to know how much you’ll need when you retire! For example, let’s revisit our 32 year old from above. If we account for inflation assuming a 3.67% inflation rate (the average US inflation from 1956–2017), in 30 years that $1.5 million turns into $4.4 million needed at the time of retirement! If she had saved $1.5 million she would have ended up running out of money much sooner than expected.

Once you’ve figured out how much you need and for how long, you can really start to find “your number” that’s needed for retirement. I created a spreadsheet where I can enter in my own personal information to help me plan for the future. I took into account possible Social Security income, average market returns, and inflation. You can check out the spreadsheet HERE and put in your own information!

But then I found FireCalc. FireCalc is a fantastic website that basically let’s you do your own Trinity study with your personal information. You can do everything that my spreadsheet does while also seeing your portfolio performance under all past market conditions and adding in different expenses for different time periods. While I put a lot of love into my little spreadsheet, it pales in comparison to what FireCalc can do.

Use the information above to make a plan for your retirement. Future you will thank you.