How to Estimate How Much Money You'll Need to Retire

Four coin-filled, graduated-sized jars with seedlings that represent the steps to estimating your retirement needs

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Everyone has a different picture of what their retirement will be. That means the amount of money you'll need to retire can be much more—or far less—than others your age. What you want to do is to come up with a personal estimate.

You start by calculating the amount of money you expect to spend each month after you retire. This calculation is the most important step you can take. If you want to spend more in retirement, you'll need to have more savings. Your retirement age will also have a big impact on how much you'll need. If you want to retire early, you'll need far more saved than someone who plans on working longer.

Following these four steps will help you come up with your estimate of how much money you'll need to retire.

1. Estimate Your Annual Expenses

Your first step is to estimate how much you think you will spend each year in retirement, including an estimate of taxes you will pay on retirement income. Start by looking at how much you spend each month on particular things. Some items may change once you've retired. For example, clothing costs may go down, but travel expenditures may go up. Multiply your estimate of your monthly expenses by 12 to come up with a base annual amount.

Add in allowances for expenses that occur yearly, such as car registration and insurance premiums. Also, take into account expenses that don't fall on a simple monthly or yearly schedule, such as replacing the roof on your house or dental surgery.

2. Add Up Income From Guaranteed Sources

The second step is to figure out how much retirement income you will have from guaranteed sources, including pensions, Social Security, and monthly annuity payments. The more guaranteed income you will have, the less you will have to rely on your savings from retirement or bank accounts.

3. Calculate the Gap and Determine Your Savings Needs

The third step is comparing your guaranteed income to your estimated retirement expenses and calculating the gap between them. For example, if you have $50,000 of estimated annual retirement expenses and $30,000 of guaranteed income, your gap is $20,000.

This gap represents the annual amount that you will need to withdraw from your savings and investments each year. Multiply the gap by the number of years you expect to be retired to create an estimate of how much you'll need to have saved to be adequately prepared for retirement.

Ideally, at least half of your estimated retirement expenses will be covered by guaranteed income by the time you reach age 70. If that isn't likely to be the case, you may want to consider buying an annuity to provide additional guaranteed monthly income.

4. Create Best- and Worst-Case Scenarios

Variables like the rate of return on your investments, life expectancy, inflation, and your willingness to spend the principal will have a big impact on the amount of money you will need to retire. To account for these variables, you will want to develop both a best- and worst-case scenario.

A best-case scenario would assume average to above-average returns on investment, average life expectancy, and low inflation. A worst-case scenario assumes below-average returns, above-average life expectancy, and high inflation. If your retirement planning only works if you get a best-case outcome, you need to figure out a different path. Perhaps you'll need to work longer, save more, or spend a little less in retirement to get your plan on solid ground.

You'll feel much better once you have spent the time required to plan for your retirement. And if you're feeling overwhelmed by all of the variables involved, consider hiring a qualified retirement planner.