The short answer: your retirement savings portfolio needs to be about 25 times the size of your net annual retirement spending.
If you want to spend $40,000/year in retirement and you don’t have any pension or other income, then you’re going to need a million bucks in the bank. If you have a military pension, then your savings portfolio needs to be about 25 times the amount of your net annual retirement spending that’s not already covered by your pension. If you have a $30,000 pension against your $40,000 retirement budget, then you only have to cover $10,000 and you’ll only need $250K in savings.
The long answer comes from a number of research studies and retirement calculators. The oldest of them all, the “Trinity study”, found that the most successful retirement portfolios survived for 30 years by starting at an annual “safe withdrawal rate” (SWR) of 4%. That initial SWR was raised each year by the rate of inflation (the CPI).
25 times annual spending may seem like a lot of money, and spending just 4% of your portfolio (plus inflation) seems simplistic. There are just too many other variables. What if you have to put a new roof on the house or buy a new car? What happens to your spending if inflation soars or the stock market tanks? What if you live 40 or even 50 years in retirement?
25 times annual spending is a low number, too. It assumes that you’ll consume the principal of your portfolio over the years and that you’ll “die broke”. If you’re concerned about living longer or if you don’t want to touch the principal then you may need to save even more! Research indicates that retirees living off their stock dividends have saved as much as 33 times their annual spending. So what’s really the right number?
Enter the calculators. There are dozens of different websites, programs, and spreadsheets. Most use historical data to “predict” the future, or sophisticated returns modeling, or detailed spending plans. Some take only a few minutes to enter data and run while others take hours of fiddling with inputs. One of the most popular is FIRECalc with its different types of analysis.
Most calculators don’t really recognize that your retirement spending will fluctuate. Some retirees cut back in the first few years of retirement until they feel comfortable and confident enough to loosen the purse strings. Others embark on huge spending sprees as they enjoy fantasy vacations and home renovations. Locations and lifestyles change with age. Some financial analysts even claim that retirement spending drops off dramatically when people reach their 80s, although their healthcare expenses may rise.
Most calculators do a poor job of estimating variations in retirement spending, and humans continue to make emotional decisions that calculators can’t predict. No matter how much money you have, you might find yourself traveling less if gas prices shoot up. If restaurants suddenly get more expensive, you might frequent cheaper places or even eat out less. If the market tanks or the economy goes into recession, you may find it hard to plan for a fantasy vacation. You’re probably already making conservative estimates of your spending, and if times seem tough then you’ll probably defer non-essential expenses or even cut back on your lifestyle.
The spending estimate involves other assets, too. Military retirees may find that their pension (with its COLA) covers a substantial fraction of their retirement expenses. Reservists and National Guard retirees will start a pension (and healthcare) at age 60. Even if you have a military pension, you may be starting a bridge career or your spouse isn’t ready to stop working yet. Despite the dire predictions of Social Security’s insolvency, you’ll have some form of this inflation-adjusted annuity. Depending on paychecks and pensions, your retirement spending may start out higher than 4% of your portfolio and drop over time.
Last week’s posts encouraged you to track your spending (how’s that going?) and to develop a retirement budget. Now that you’ve made some rough estimates, you’re ready to figure out how much you’ll need. Don’t worry if the number’s way too big for your savings budget or your timeline– we’ll show you how to tweak your plan to match your goals.
I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers and veterans.