Calculating Retirement Expenses
To calculate your retirement expenses, consider each spending category, as well as any changes you plan to make during retirement. For example, if you plan to move, will the cost of living be higher or lower than your current situation? If you intend to retire before the age of 65, you will likely need to pay for health insurance unless you are covered through a working spouse. The cost of health insurance is determined by age, so you should be prepared to pay a significant amount until you become eligible for health care through Medicare.
Calculating Retirement Income
To calculate your retirement income, look at all your retirement accounts. How much will you receive from Social Security? Do you have a 401(k) or 403(b) with your current employer? Examine the amount of income they will generate. Do the same with any IRA accounts or investment and savings accounts you plan to use to fund your retirement. A retirement calculator or qualified financial planner can help you with these numbers.
Calculating the Gap
Let’s say you’ve determined that in order to meet your retirement expenses, you’ll need about $71,000 in annual gross income (including what you will pay in taxes) and that Social Security will provide about $21,000 per year.
Your gap will be: 71,000 – 21,000 = $50,000. Now you know that you’ll need to withdraw about $50,000 per year from your savings and investments. How much money will you need to invest to generate $50,000 a year in cash flow? This depends on two things: the rate of return your investments earn and whether you are willing to spend principal.
If your investments earn an annual return of 5%, you would need $1 million to generate $50,000 ($1,000,000 × 5% = $50,000) in annual income, without spending principal. After twenty-five years, you would still have a million dollars. However, this does not account for potential inflation and/or taxes.
If you decide that it is acceptable to spend principal down to zero by the time you die, you would need about $725,000 yielding 5% annually to last for 25 years. After twenty-five years or so, you would have spent all the money.
In this simplified calculation, the answer to the question of how much you need for retirement ranges from $750,000 to $1 million.
Reviewing the Gap
Two additional factors affect the amount of money you will need for retirement: inflation and life expectancy.
Note: Unless you know exactly how long you will live, how much you will spend each year, and how inflation will impact you, you won’t be able to determine exactly how much money you will need for retirement.
Since you cannot know exactly how much money you will need, a good alternative option is to create best-case and worst-case scenarios. In the best-case scenario, you assume average investment returns, low inflation, and controlled spending. In the worst-case scenario, you assume below-average investment returns, high inflation, and unexpected expenses.
You can also run different scenarios where you delay starting to take Social Security benefits until you are 70 years old to receive a higher monthly amount. If you still want to retire at 66, your gap amount will be higher in your sixties but much lower when you turn seventy. Visualizing these scenarios in the form of a retirement income timeline can help clarify decisions that may reduce the total amount you need for retirement.
Questions
Frequently Asked Questions (FAQs)
How much will I receive from Social Security benefits when I retire?
The Social Security Administration has several tools that can help you estimate your retirement benefits. To get a general idea of what you can expect based on your age and salary, you can use the quick calculator. You can also use the retirement estimator for detailed information about your actual earnings record.
How will my withdrawals from my 401(k) be taxed when I retire?
Qualified withdrawals from a 401(k) are taxed at ordinary income rates. The exact rate will depend on your total income and where you fall within the overall tax bracket.
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Source: https://www.thebalancemoney.com/how-to-calculate-how-much-you-need-to-retire-2388825
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