How Much Do You Need For Retirement?

A pretty simple way to estimate how much money you need for retirement is: 

1. Calculate how much annual income you want (or need) in retirement, using current dollars. 

2. Subtract the amounts of Social Security benefits (including your spouse's benefits, if you're married), and pension income, if any, you (and your spouse, if married) expect. 

3. Multiply by 30; we'll call the result your nominal target. 

4. Adjust for inflation between now and your anticipated retirement age, by multiplying 1.03 by itself the number of times equal to the number of years until your retirement (i.e., 1.03 to the exponential power equal to the number of years until your retirement), and next multiplying the resulting number by the nominal target. The number you end up with is your inflation adjusted target.  (This calculation is based on a 3% inflation, which is roughly in line with the average since World War II.)

Here's an example. Let's say you'd like the inflation adjusted equivalent of $50,000 (in current dollars) a year for retirement. Your estimated Social Security benefits are $15,000 a year. You're lucky enough to have a pension that will pay $10,000 a year when you retire. Subtracting $15,000 and $10,000 from $50,000 leaves $25,000. Then multiply $25,000 by 30, getting $750,000.  We'll assume you have 20 years to go before retirement. Multiply 1.03 by itself 20 times (that would be 1.03 to the 20th power, exponentially speaking). The result is about 1.8061, which you multiply with $750,000, getting $1,354,500 as your approximate inflation adjusted target. 

 If you have no pension, which is the case for most Americans, you'd subtract your $15,000 Social Security benefits from $50,000, getting $35,000. That figure multiplied by 30 yields $1,050,000. Multiply by 1.8061 to account for inflation, and your target becomes $1,896,400. 

Note that your target number is in future inflation adjusted dollars. Since most people's incomes tend to increase in line with inflation, reaching the target isn't quite as hard as you might think. You can use this target without having to think about investment options or diversification strategies. Tired of stock market volatility? Slick financial advisers make you nervous? Don't want to invest in derivatives contracts or no money down real estate deals? That's okay. Save in CDs and money market accounts if you want. Work a second job, or drive the same car for 20 years. Don't splurge on a McMansion and learn the virtues of home cooked meals. Inherit the money, win the lottery, or get it any other way that's legal. It doesn't matter how you get the money, so long as you have enough. 

This formula is just an approximation, and is meant to give you a ballpark sense of where you need to go. We assume that you're retiring in your early 60s (most people do so around age 62). That's why we use a multiplier of 30--many financial advisers would use a multiplier of 25, but they're assuming retirement at age 65 or later. The multiplier of 30 also helps account for the fact that most pensions are not increased for inflation, so they lose value over time. We also assume that once you've accumulated the needed total, you'll invest it in a conservatively diversified portfolio during retirement, including some stocks and bonds. If you want to stick with all CDs in retirement, you should use a larger multiplier, like 35 or 40. 

Of course, this money isn't for your kids' college expenses or other non-retirement uses. That has to be saved in addition to your retirement money. It isn't easy to save for retirement. Then again, nothing worthwhile comes easily. Most people go through life and then retire on whatever they have when retirement time rolls around. Even if you can't imagine how you'd ever reach your target, starting to save is the only way you'll get there. If you don't start, you won't succeed.  Many folks would be happy to accumulate half their target. But they have to start saving to get there. The worst thing you can do is nothing.  Good luck.