How Much Money Will You Need In Order to Retire
There are presently three generally accepted rules or principals for determining how much money you will need to retire.

1. You will probably need an income in retirement about the same as you are currently spending.

2. You cannot anticipate for inflation so you must think in current dollars.

3. You should save enough money so that you can live on the interest of your savings of 5%
In this article we will look at these three principals and how they apply to your retirement goals. Let's start with what your spending needs will be when you retire. First you need to deduct any current expenses that will disappear when you retire. There are usually two major expenses that you may currently have that will no longer apply when you retire. If you still have kids in school then once you get beyond the college tuition phase those expenses will go away. Many people are close to paying off their mortgage so that expense may also go away. Beyond those two major areas most other expenses will most likely just shift in emphasis. Commuting expenses may go away but travel or vacation expenses may go way up. While most people think their needs will diminish when they retire they often overlook the fact that they will have more time on their hands and may want to get involved in new activities, travel more, spend more on recreation and education, etc. So the general rule is that although you can cut your expenses when you retire chances are that you will be happier and enjoy your retirement more if you can maintain the same general economic level.

One of the major questions that arises is how do I anticipate what prices will be in the future and how do I factor that into my economic calculations. The answer is that you cannot anticipate what future prices will be you need to make your calculations based on today's dollars. One of the ways that inflation is factored in is that the dollars you save today are earning interest and hopefully appreciating through your investment returns. All things being considered the value of you investment should rise proportionally with the increase in inflation. Although our article 'Inflation- Slight of Hand' raises some serious questions on that front. Another way of dealing with the increased cost of living is how your retirement funds are handled once you retire.

When the life expectancy was shorter say 5-10 years beyond retirement it was easier to take your retirement funds, divide them by say 15 and spend that amount each year anticipating that the funds would not be exhausted before you were. Now a days people are living 20 or 30 years beyond retirement age and things have changed. One big factor is that people are staying healthier and more vital longer and can now continue to work longer (see our article on 'Why You Should Work After You Retire' ) which can significant extend their retirement funds (at a 20 to 1 ratio). The other is that being more vital and active people require more money to do more things. In the old days people used to talk about the wealthy in that they lived off the interest on their money they did not touch the principal. That same way of thinking is now currently being applied to retirement income. The rule of thumb is to take 5% of your retirement funds out per year as the money you will live on. This plan is based on two other factors: the first is that you will earn more than 5% on your funds, hopefully in the 7-8% range so that in essence you are not reducing your funds they are actually growing each year. The other rule is that you increase the 5% figure each year based on the rate of inflation. If inflation was 10% the next year you would take 5.5% (not 15%) and that would be your new basis. The idea again is that if you earn more than you take out then the next year your basis is larger and it helps compensate for the effects of inflation. On paper this sounds like a great plan the problem is in accumulating enough money to make the plan work. If for example you were now living on $100,000 per year then after you deduct your income from social security say $25,000 you would need a net of $75,000. Factoring in money for taxes you would be back up to needing around $100,000 from your retirement fund. Since you are taking out only 5% you would need a retirement fund of 2 million dollars to make this all work. Therefore your goal should be to have $2 million dollars in your retirement account when you retire.

For many of us this is an unattainable number and here is where the work factor comes in. 5% is really one twentieth of the amount you need in savings. What that means is that for every dollar you earn you can reduce the amount you need in savings by a factor of 20. If you for example were able to earn $30,000 a year in your retirement you would need $600,000 less in your retirement account to have the same amount of income. So another way to look at the situation is that rather than waiting until you had $2 million in retirement savings before you retired you could retire when your savings reached $1.4 million if you could continue to make $30,000 a year. For most of us this scene rio makes retirement at an earlier age much more feasible. If you made more than $30,000 then you could add to your retirement fund in anticipation of the point when you would no longer be able to work. In fact the one drawback to this approach is that when you stop making any income your yearly draw would be reduced. While this is true other factors come into play. If you have reached the age and physical condition where you can no longer work, then you are probably at the point where you have greatly reduced you travel and extracurricular activities so that your financial requirements are probably going to be considerably less.

The one factor we have not talked about are medical expenses which can have a serious impact on your savings and costs. This subject is actually handled in another article.