Many people don’t retire simply because they’re afraid they haven’t saved enough. The fear’s not surprising since we’re constantly bombarded with contradictory and confusing financial headlines. Take a look at these real headlines I found after a quick Google search…
- Is $1 Million Enough to Retire?
- How to retire happily on less than $1 million
- Retire at 45 with $500K: Is It Possible?
- How To Retire Comfortably With Just $500,000
- Can You Retire With $2 Million?
Sheesh! What to do?
Well, I wish I could tell you that there is a simple answer to the question of how much you need to retire, but the true answer is – I’m sorry to say – it depends. It depends on your particular post-retirement spending, your age, your assumptions about longevity, taxes, social security, pensions, and more. And, of course, it depends on how much wealth you’ve accumulated for retirement.
There are lots of different ways of figuring out how much you need to retire – you can hire a Financial Advisor, use a retirement calculator, build a spreadsheet, or use a crystal ball. But I’m going to focus on what I did before retiring in 2012 because it made sense to me then and still makes sense to me now. If I’m lucky, it’ll make sense to you too. 🙂
I’ve boiled down the process I used into four steps.
Step 1: Estimate your annual spending during retirement
The first thing I did to decide if we had enough to retire was estimate our annual retirement spending. If you haven’t been tracking a budget or actual spending, now is the time to start. If you’ve been tracking, then – congratulations – you already have data to work with.
I already had a budgeting process before I retired so I started with that. Then I adjusted each estimated expense to reflect what would happen in retirement. Here’s what changed:
- Health insurance went up: I no longer had subsidized health insurance from work. We initially purchased expensive private insurance, but switched to Obamacare as soon as it became available. Our Obamacare insurance premiums turned negative (yes, we made money) when our Obamacare Subsidy kicked in and we purchased a HDHP.
- Automobile expense went down: I no longer needed to commute to work, so there was a savings on gas and maintenance. We eventually sold one of our two cars and lowered expenses further, but I didn’t count on that in my original estimate.
- Health Savings Account went up: I now had a HDHP and I wanted to add as much to the HSA as possible.
- Travel expense went up: We were planning on traveling more once we had more free time.
- Taxes went down: Taxable income went way down because I had sufficient post-tax money to live off of.
All other expenses stayed pretty much the same.
Our housing expense initially stayed the same because we stayed put. But ultimately it went down when we went through the process of downsizing, sold our home, and rented an apartment in downtown Philly.
After we downsized to Philly, one increasing expense – eating out – surprised me. There are just too many great restaurants in the city and, like the Borg, resistance is futile. Besides, we love to dine out and we eat at cheapish restaurants so we get an excellent Happiness Return on Investment.
Step 2: Add a Safety Margin
After I estimated annual spending, I still wanted to add a Safety Margin in case things went haywire. I wanted an amount big enough so I could sleep at night. I added $20,000 to our annual spending budget.
I think a reasonable number is somewhere between $10,000 and $50,000. Anything below $10,000 feels like every hiccup – unexpected car replacement, serious illness, major home repair – could blow the budget. More than $50,000 seems ultraconservative to me. How many things could all of a sudden cost an extra $50,000 year after year? But in the end, you’ll have to decide how much is enough for you. There’s no magic formula.
Step 3: Estimate how long your savings need to last
This step is quick and just a wee bit morbid – you have to estimate the how many years you have to live. I used the Vanguard Calculator for Longevity which is a tool that estimates the probability that you and your spouse will live a certain number of years. Here’s a screenshot that shows the results for Mrs. FF and me:
The mysterious Either column shows the probability that at least one of you will survive for a certain number of years.
I fiddled with the calculator until there was a less than 10% probability that either of us would be alive. Right now, we have an 8% chance that one of us will be alive in 41 years which means one of us would be 98 years old. Yikes!
Mrs. FF has a good shot at making it to 98 – she has good genetics and a healthy lifestyle. And me? Well, I have suspect genetics so I’ll probably be dust in the wind. Hopefully it’ll be a warm wind because I like it warm. 🙂
Anyway, you should pick whatever probability feels comfortable but I suggest a range of 5% to 20%. Anything more than 20% means you could have a greater than 1 in 5 chance of outliving your wealth.
Step 4: Calculate how much you need to retire
I picked FIRECalc for calculating if I had enough to retire. Why FIRECalc? Two reasons. First, FIRECalc lets you enter a reasonable amount of detail, but not so much that you start to lose your mind.
Second, FIRECalc runs many simulations to see how your retirement savings would have performed had you retired in different years. For example, let’s say you enter all your data and then run FIRECalc. FIRECalc first looks at what would have happened to your retirement savings if you’d retired in 1871. Then it looks at what would have happened if you retired in 1872. And then 1873, 1874 and so on all the way up to today minus the number of years your retirement savings has to last.
Think about that. That means FIRECalc looks at what would’ve happened to your retirement savings if you retired in 1929 just before the stock market crash and the Great Depression. Or if you retired at the start or end of World War II. Or if you retired just before the high inflation of the 1970s and early 1980s. That’s a boatload of bad scenarios! If your retirement savings can survive all that turmoil, you’ll probably feel at least somewhat confident you have enough to retire. And when you realize you also have a Safety Margin built-in, you’ll feel even more confident.
History doesn’t repeat itself, but it often rhymes. – Mark Twain (maybe)
Now I realize that history doesn’t exactly repeat itself and you can up with some catastrophic events – nuclear war, environmental disaster, plague, space aliens, whatever – that could destroy my retirement savings even though FIRECalc said everything is groovy. But at that point, I’d be either dead or have more important things to worry about than my retirement savings. It helps me to remember that there are no 100% guarantees in life, so it’s not worth worrying about highly improbable events.
So let’s move on to how I actually used FIRECalc. I prefer to keep my personal financial information private, so let’s talk about John and Mary, a hypothetical couple. Here are their particulars:
Current net worth: $2,000,000
Annual spending: $50,000 budget + $20,000 Safety Margin = $70,000 total
John’s Age: 45
John’s annual Social Security at 70: $20,000
Mary’s Age: 45
Mary’s annual Social Security at 70: $10,000
Number of years their savings must last: 53
John goes to the Start Here tab where he enters Spending, Portfolio, and number of Years their savings must last:
Then he jumps over to the Other Income/Spending tab and enters social security information:
Then John moves on to the Investigate tab, finds the Given a success rate, determine spending level for a set portfolio, or portfolio for a set spending level section, selects the Starting portfolio value radio button, and enters a success rate of 100%:
Finally, John hits the Submit magic button and after some screen flashing he sees the following:
The screen shows that John needs about $1,862,000 to retire with a 100% success rate, but he already has $2,000,000. Hallelujah – John has enough to retire now according to FIRECalc.
There are many other bells and whistles you can play with on FIRECalc, but this gives you a pretty good idea of the basics and what I did.
I like FIRECalc, but just a small warning – pay attention to the last time the data was updated. The latest as I write this was May 2017. That’s not bad given there is data back to 1871, but it’s still worth keeping an eye on.
Well, this describes the approach I used back in 2012 and it’s worked well so far here in 2017. In fact, we are now under spending by more than our Safety Margin. Our Safety Margin was $20,000 back in 2012, but according to FIRECalc we can now support a Safety Margin of $37,000. Such is the lucky life of riding a crazy bull market since retiring. But also, sticking to your budget means that, on average, you’re going to add more Safety Margin money to your retirement savings each year which starts compounding additional returns.
Thanks for reading! What do you think? Does this approach make sense? How do you figure out if you have enough to retire?