How to Calculate How Much You Need to Retire

Calculate the gap between what you will need and guaranteed sources

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To determine how much money you will need to retire, you will need to have an accurate estimate of your retirement expenses and your guaranteed sources of retirement income. Then, you can calculate the gap between those two numbers and determine how much money you would need to save to fill in that gap or how much you would need to reduce expenses.

You can use the example below to calculate this amount yourself, use an online retirement income calculator, or hire a qualified financial planner to help you.

Key Takeaways

  • To calculate how much money you need to retire, estimate your retirement expenses, and compare them against your retirement income.
  • You can use your current budget as a starting point, but don’t forget to account for any changes in spending categories after retirement.
  • To estimate your retirement income, look at all sources of income, including Social Security, IRAs, investment accounts, and savings accounts.
  • Because you can’t predict your life expectancy or inflation, it’s wise to develop several scenarios for your retirement income.

Calculating Your Retirement Expenses

To calculate your retirement expenses, consider each spending category, along with any changes you plan to make in retirement. For example, if you plan to move, will the cost of living be higher or lower than where you are now? If you're retiring before age 65, you'll most likely need to pay for health insurance unless you're insured through a working spouse. Health insurance is priced based on age, so be prepared to pay a significant amount of money until you qualify for Medicare.

Your current budget can be a good starting point, but make adjustments for factors that will change once you retire.

Calculating Your Retirement Income

To calculate your retirement income, look at all of your retirement accounts. How much will you receive from Social Security? Do you have a 401(k) or 403(b) with your current employer? Look at how much income that will generate. Do the same with any IRAs, investment accounts, and savings accounts you plan to use to fund your retirement. A retirement calculator or financial planner can help you with these numbers.

Calculating the Gap

Suppose you have determined that in order to meet your retirement expenses, you will need about $71,000 of gross income per year (including what you would pay in taxes) and that Social Security will provide about $21,000 per year.

Your gap would be: $71,000 - $21,000 = $50,000. Now you know that you must withdraw about $50,000 per year from your savings and investments. How much money would you need to have invested to generate $50,000 per year of cash flow? That depends on two things:

  • The rate of return that your investments earn
  • Whether you are willing to spend principal or not

If your investments are earning a rate of return of 5% per year, you would need $1 million to generate $50,000 ($1,000,000 x 5% = $50,000) per year of income, and not spend any principal. Twenty-five years later, you would still have $1 million. However, that does not take into account the possible effects of inflation and/or taxes.

If you decide that it is okay to spend the principal down to zero by the time you die, then you would need about $725,000 earning 5% per year to last for 25 years. After 25 years or so, you would have spent all of the money.

In this simplified calculation, the answer to how much you need to retire ranges from $750,000 to $1 million.

Revising the Gap

Two additional factors influence how much you will need to retire: inflation and life expectancy.

Unless you know exactly how long you will live, how much you will spend each year, and how much of an impact inflation will have, you can't know exactly how much money you will need to retire.

Since you cannot know exactly how much you will need, the next best thing is to develop both a best-case and worst-case scenario. In your best-case scenario, you assume average investment returns, low inflation, and controlled spending. In your worst-case scenario, you assume below-average investment returns, high inflation, and unanticipated expenses.

You can also run various scenarios where you'll delay the start of Social Security until you're age 70 so you'll get a higher monthly amount. If you still want to retire at age 66, your gap amount will be higher in your 60s but much lower once you reach 70. Projecting these scenarios in a retirement income timeline format can help you see which decisions may lower the total amount you'll need to retire.