How much money do you need to retire?

That one day when you can finally retire.

Sounds pretty nice, doesn’t it?

But how much money do you need to get there?

I can tell you one thing: it’s a lot.

It’s probably more than you realize. So if you haven’t already, start saving now.

As for an exact number to shoot for? Well, it depends on a few things, but you can estimate it.

This post explains the “4 percent rule”, which is commonly used for a quick gauge of how much you need for retirement.

It’s pretty good overall but has some limitations.

I’ll also give you some steps to help you plan for that glorious retirement day.

What is retirement?

Before I start I just want to quickly define “retirement.”

Some people may have different ideas of what it means.

For some (maybe most), it means you don’t have to work at all anymore. For others, maybe they still work part-time.

For me - and when I talk about retirement - it means financial independence. It’s the point where you don’t rely on an outside entity (a company or individual) for income.

If you don’t want to, you don’t have to work a regular job ever again. Your investments can do all the work for you.

Sound good? Let’s continue.

So how do you get there? How much money should you have saved?

Four percent rule

If you've read about this topic before, you may have stumbled upon the 4% rule.

The 4% rule says that you can safely withdraw 4% of your savings each year without depleting your money.

If this is true, then we can estimate how much you need to retire. You will need the amount for which 4 percent covers your annual income.

<;|\frac{1}{0.04} \times \text{annual income}|;>

If you plan to spend $50,000 each year in retirement, then you will need $1.25 million.

Pretty simple.

It assumes, based on historical data:

<;|7 \% \text{ return} - 3 \% \text{ inflation} = 4 \% \text { real return}|;>

Now this rule isn’t perfect. There’s actually a bit of controversy around how good it is.

I think it’s still a great starting estimate. But let’s go through some potential notes of caution.

Some Notes of Caution

The four percent rule gives you a decent estimate of what you need to retire. But it comes with a few notes of caution. Here are the things to be aware of.

Seven Percent Return is No Guarantee

The 4% rule assumes a 7 percent return on your investments. It’s a good average based on historical data.

But the historical data assumes a certain kind of investment mix. Depending on your portfolio makeup, you may see very different results.

Usually before retirement, people tend to favor stocks. They have high average returns but also are considered riskier.

Usually in retirement, people favor lower-risk investments like bonds. Because they have less risk, they also have lousier returns.

If your portfolio is 80% bonds, then you won’t be seeing this 7% annual return.

If your portfolio is 80% stocks then you may see the 7% return on average, but you’ll see much more volatility.

The 4% rule assumes an investment mix of about 60/40 stocks to bonds. If your portfolio varies drastically from that, then the 4 percent rule may not work for you.

But that isn’t to say it can’t still make for a good estimate for what you need to retire. Chances are, your investment mix will change over time.

The real question comes with whether you should actually withdraw 4% of your money each year.

The simple answer is no. If one year the market does poorly, you should probably take out less money. If another year the market does really well, then you can afford to withdraw a little more than 4 percent.

It assumes 30 years in retirement

The 4% rule is designed to work for about 30 years of retirement income.

You don’t know exactly how long you’ll live. If you retire at 65, then 30 years is probably about what you need to prepare for. But if you plan to retire early, you will need more than that.

But as it turns out, retiring early only barely changes this number. It means you will need a little more than the number calls for, but too much more.

It relies on withdrawals at a consistent rate

The 4% rule assumes you need the same amount each year in retirement.

That’s probably not the case. Your annual spending may vary quite a bit depending on your lifestyle.

When you’re young and active, you’ll probably spend more than when you get really old. So take that into consideration.

You don’t want to run out of money. But also, it’d be a shame to forgo the retirement you want just to have a ton of money left over when you die.

Don’t forget about inflation

You can’t forget about inflation. If your retirement is more than a few years away, then you’ll need to account for it.

Let’s take that example from above that said you need $1.25 million to retire.

Well, if your retirement is still 20 years away, you’re going to need more than that.

Historical inflation runs at about 3 percent per year.

So if you want to calculate how much you’ll actually need:

<;|A = P (1 + 0.3)^n|;>

Where ;||A||; is the amount of money needed for retirement, ;||P||; = present value of money needed for retirement, and ;||n||; is the number of years until retirement.

So for our example:

<;|1,250,000 (1.03)^{20} = \\$ 2.26 \text{ million}|;>

Is there a better way to calculate?

Honestly, there are so many retirement calculators out there. And many of them give you very different answers as to what you need.

So it’s hard to say.

The reality is, your number depends on a lot of things.

If you really need a number, you should probably talk to a financial advisor about your personal situation.

But if you just want an estimate, I think the 4% rule (or “Multiply by 25”) rule is good enough. If anything, it tends to be an estimate on the high side.

How to plan for retirement

Here’s how you can plan for that beautiful day.

Identify your primary goal

Do you want to retire early? Would you rather live extravagantly while young?

The lure of retirement is the idea of freedom. You don’t need to worry about having money. You don’t need to rely on a job or another individual for income.

That’s an appealing proposition. For many, it’s worth sacrificing a certain current lifestyle to achieve.

But others want to live it up while they’re young. They want to travel, live adventurously, and spend money maximizing experiences. You’re able to do more when you’re young, so it may make sense to spend more.

Chances are, you’ll want somewhat of a balance. You want to do what you can to save money for a sooner retirement. But you also don’t want to miss out on opportunities today.

Whatever your priority, you should have a goal. Maybe that goal is to retire comfortably by 65. Or 55.

Your goal should give you some direction - and some realistic expectations. Retiring early is hard. Many brokerages have tools to help you track progress as you work toward your goal.

Invest with a retirement account

To save for retirement, make use of tax-advantaged investment accounts.

If your employer offers a 401(k), use it. Especially if they match part of your contributions.

Consider opening a Roth IRA. It’s a fantastic way to save for retirement that offers some benefits you don’t get from a traditional 401(k).

If you have a high deductible health plan, see if you qualify for an HSA. It’s the best way to save for medical expenses in retirement.

And if you want to retire early - before you turn 59 ½ - then you will probably want to contribute to a traditional brokerage account. This account doesn’t get the tax benefits that a 401(k), IRA or HSA gets, but it allows you to withdraw your money at any time without penalty.

It’s best to contribute to these accounts on a regular basis. Make it a part of your monthly budget.

Save and invest even more

If you haven’t already, start saving for retirement today with a 401(k) or IRA.

If you’re already saving, that’s great. Save more.

Put as much as you can into one of those investment accounts.

Live below your means. Just because you can afford it doesn’t mean you should have it.

Regardless of your priorities, you must save for retirement. Once you’ve paid off high-interest debt and built an emergency fund, retirement savings comes next.

Aim to save at least 15 percent of your income for retirement. If you want to retire early - or are behind - save more. Try 30 percent of your income. Or as much as you can.