An Expert Guide to Calculating How Much Money You Really Need in Retirement
Rather than fixating on a specific savings goal, pre-retirees should focus on building a flexible income strategy that accounts for actual monthly expenses and can adapt to life's unexpected changes.
More Americans are growing concerned about their ability to afford retirement.
A recent survey from Northwestern Mutual found that 48% of Americans believe they'll outlive their savings.
Many also believe they'll need at least $1.46 million in savings to retire comfortably in 2026, a $200,000 increase from 2025.
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It can be easy to hyper-focus on having a certain amount saved before retirement, but without a strategy to turn those savings into reliable income, even the most substantial nest egg may not last.
Whenever surveys like these come out, people shut down after hearing they'll need to have a million dollars in retirement savings. What's often missing from the conversation is how that number is actually calculated.
Many pre-retirees start by estimating how much monthly income they would need to live comfortably. Others use the income replacement ratio (IRR) method, which is calculated by estimating the pre-retiree's average gross salary during their final three years of employment and assuming they'll need about 60% to 80% of that amount each year.
Pre-retirees can also use the 4% withdrawal rule, which suggests they may be able to withdrawal about 4% of their retirement portfolio in the first year of retirement, adjusting that amount for inflation each year thereafter.
Some may choose to take a more detailed approach by building a retirement budget that includes both essential expenses and discretionary spending.
It's important to note that these methods are great starting points, yet they may not take into account market downturns, long-term care needs, reduced Social Security benefits, higher taxes or taking care of adult children.
While it can give you a ballpark range to aim for, setting a target savings number doesn't account for unexpected life events, such as a medical emergency, job loss or a sudden drop in the value of investments.
Oftentimes, these estimates are based on assumptions that do not reflect real-life conditions.
The transition from earning income to living off of savings brings uncertainty regardless of how much money is sitting in retirement accounts. Instead of receiving a consistent paycheck, retirees must rely on their savings to generate income.
This introduces a new set of challenges to navigate, such as withdrawal strategies, healthcare expenses and tax management. Rather than building savings, the focus shifts to sustaining them.
When it comes to creating a withdrawal strategy that works for you, start by developing an expense and budget plan.
- Make a list of your expected annual or monthly expenses, including mortgage or rent payments, property taxes, insurance premiums, utilities, healthcare expenses as well as credit card and loan payments
- Calculate your guaranteed income from sources such as Social Security or pensions.
- Subtract that amount from your annual expenses to determine how much money you'll need from retirement savings or investments to fill that gap.
Once you know how much income your portfolio needs to generate, you can utilize investment strategies. Depending on your goals, risk tolerance and timeline, this may include a combination of income annuities, bonds, certificates of deposit (CDs), dividend-paying stocks, alternative investments, reverse mortgages or other investment vehicles.
After establishing an asset allocation strategy, you can implement a withdrawal approach that aligns with your spending needs.
A strategy that could work for you
For some, the bucket withdrawal strategy might be the best approach. This method puts your savings into short-term, intermediate and long-term spending buckets.
Others may follow the guardrails strategy, which allows retirees to increase withdrawals when portfolio values are rising and reduce them when the market is down.
The "go-go, slow-go, no-go" spending framework may also be worth considering. This method acknowledges that spending patterns often change throughout retirement, with higher spending in the earlier, more active years, followed by slower spending in the later years as one ages.
An important part of retirement planning is preparing for the unknown. Whether it's accounting for inflation, market downturns or longer life expectancies, a comprehensive retirement plan is built to withstand various outcomes.
Even with a solid retirement plan, mistakes can still happen. What's important is being flexible.
Refusing to modify withdrawal rates or adjust investment strategy as life changes can have long-term consequences that can be difficult to recover from.
Market fluctuations can also have a significant impact on retirement income, particularly in the first few years of retirement. When markets decline, many retirees panic and sell off their investments, which can lock in losses that can be difficult to recover from, especially if a withdrawal strategy is already in place.
And, as history has shown, those who leave the market when it's down often miss out on the rebound.
Building a sustainable income strategy starts with understanding monthly expenses.
Once a budget is in place, retirement income can be generated through a combination of Social Security benefits and investments, structured to provide day-to-day sustainability and future growth.
Chris Cohan is a registered representative of and conducts securities transactions through CoreCap Investments, LLC. Chris Cohan is an investment advisory representative of and provides advisory services through CoreCap Advisors, LLC. RJP Estate Planning is a separate entity and not affiliated with CoreCap Investments or CoreCap Advisors.
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