How Much Savings Do I Need For Retirement?
How much savings do I need to retire? Allow me to boilthe ocean down for you… it depends. At what age wouldyou like to retire? How long do you expect to live? Howflexible are your spending needs? There are numerousfactors to consider when calculating this elusive figure,and the fact is, we can only know the correct amount inhindsight. While everyone’s retirement savings target willdiffer, there is a simple question you can ask yourself tohelp you identify your “magic” number:
How much will I need to draw from my savings each yearto maintain my desired standard of living?
If your answer is “I can cover all my desired livingexpenses with an inflation-adjusted pension,”congratulations: you can stop reading now. However,given the illiquid nature of pensions and annuities, it isimportant to maintain enough liquid capital to cover majorexpenses. For example, you cannot call the Social SecurityAdministration to request a loan against future SocialSecurity benefits to replace a roof or pay an unforeseenmedical expense. Without ample liquidity, funding majorunexpected expenses may require you to take onexpensive consumer debt.
For those who will not have a large pension income, the size of their savings target will largely depend on how much they will need to withdraw from their investments to fund their retirement years. When considering withdrawal amounts, it is helpful to think in terms of percentages rather than absolute dollars.
For example, all other things being equal, a retiree drawing 10% from their $10 million nest egg will deplete their assets at a faster pace than a retiree drawing 3% from their$1 million portfolio. To that end, a good starting point for calculating a retirement savings target is to first determine how much will need to be withdrawn in year one of retirement.
Once you have determined how much will be needed from savings each year to fund your retirement, simply divide that amount by 4%. This is known as the “4% Rule”: by drawing 4% from a balanced investment portfolio (while adjusting that withdrawal amount each year to keep pace with inflation), the retiree stands minimal risk of outliving their assets. So, a $1 million investment portfolio could support a $40,000distribution that increases with inflation in subsequent years. If you need $100,000 inyear one, you should target $2.5 million in savings ($100K/4%).
If this seems too simple a solution, that’s because it is.
The 4% Rule is far from a perfect strategy, and it can lead to sub-optimal outcomes depending on each individual’s unique profile. That said, the 4% Rule is a good rule of thumb that can be used to identify key considerations when setting your savings target.But remember, a higher withdrawal rate increases the risk of running out of money during retirement. With that in mind, here are few factors to consider:
- Time Horizon – The longer a nest egg needs to last, the lower the initial withdrawalrate should be. Early retirement or family history of longevity both increase theestimated length of retirement, which should, in turn, reduce your initialwithdrawal rate.
- Risk Appetite – A reasonable long-term investment return is integral to sustaining alifelong distribution plan. Conservative investment allocations will have lowerexpected returns, which will require a lower initial distribution rate.
- Spending Flexibility – The ability to adjust consumption during years of poorinvestment performance should increase your initial withdrawal budget.
- Legacy – If you are planning to leave a sizable inheritance to your heirs, you willlikely need a lower initial distribution rate to ensure there are funds left over.
With so many variables at play, setting a savings target for retirement can be a daunting task. Cookie-cutter strategies such as the 4% Rule are oftentimes suboptimal. Given the dynamic needs and unique goals of each individual, a trusted advisor can help you construct a custom plan and make formulating your personalized strategy much less intimidating.
Tucker is the director of wealth planning and a portfolio manager. He is responsible for providing in-depth insights into wealth planning and investment management. He provides tailored advice to clients, helping them confidently navigate life’s planned and unplanned events.
Before joining the firm, Tucker was the trust operation director at Clayton Bank and Trust in Knoxville, TN serving wealthy families in east Tennessee. He is a Chartered Financial Analyst® and a Certified Financial Planner™.
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