How Much Money Will You Need In Retirement?

In the realm of personal finance, determining how much money you’ll need for retirement is definitely one of the most important and difficult things to figure out.

The common advice today is to pile up enough money so that when you retire, you will be able to withdraw an amount every month equal to 80% of your pre-retirement income. Personal finance websites such as Investopedia and The Motley Fool recommend this, while CNN says 70% might be enough.

There are a couple problems with this method of planning for retirement.

First, it doesn’t consider how much money you think you’ll spend in retirement.

For example, let’s pretend that you are planning to retire exactly one year from today.

In order to be absolutely positive that you can actually afford to retire, you sit down to crunch the numbers one more time. Which number is going to be more important to you: how much money you made last year, or how much your expenses are every month?

In other words, who cares what your salary used to be? The most important question is, will you be able to pay your bills every month after you retire?

The second problem with planning for retirement like this, is this advice is the same for everyone, regardless of each person’s financial situation and spending habits.

Put simply, someone who is frugal by nature and is debt-free won’t need as much money in retirement as someone who has a mortgage, a car loan, and is a bit more carefree with his money, for example.

According to the 80% rule, someone who is earning $45,000 at the end of their career would need $36,000 every year in retirement, while someone who is earning $200,000 would need $160,000. If the first person can live on $36,000/year in retirement, then why can’t the second person as well?

Does that person really need to generate $124,000 more than the first person every year? What if he or she can live on just $50,000/year?

One flat formula shouldn’t be applied to everyone’s retirement situation.

To calculate how much money you’ll need in retirement, add up all your expenses for the last year.

Recording expenses like food, utilities, cell phone, and gasoline should be pretty easy since they likely occur every month, but don’t forget to include expenses that you might only pay once or twice a year, like real estate tax and auto insurance.

This will be much easier to do if you keep a budget or use a personal finance program like Personal Capital, Mint, or You Need A Budget. Just navigate to the page that shows you your expenses for the last year.

You should be able to get a list of your past year’s expenses at your credit card’s website as well.

You’re almost done, but don’t forget to write down one more expense: what about vacations and other leisure activities you plan on doing? You likely will go on more vacations once you’re retired, so don’t neglect to record a dollar amount for those trips as well.

Even if you don’t know exactly how much your vacation will cost, or even where you will go and for how long, at least make a guess so you don’t get blindsided by the cost of a trip.

To give yourself some wiggle room, add between five and ten percent to your yearly expense total to account for inflation.

Once you know how much money you need to pay your bills for a full year, take that total and divide by twelve to see your monthly expense total.

Now compare that amount to how much money you think your retirement account will generate for you every month. Don’t forget to include calculations for income from social security and a pension, if you have one.

If it doesn’t look like you’ll earn enough money to pay your bills every month, you may need to increase your retirement savings rate and/or work several more years before retiring.

But if your retirement accounts are on track to earn more money for you every month than you think you’ll spend- congratulations! Your retirement plans are in good shape.