Retirement Income Planning - How Much Money Do You Need to Retire?

Written by John Macy, Financial Coach, MBA, Retirement Income Certified Professional® (RICP)

The key to retirement income planning and a secure, satisfying retirement isn't a single one-size-fits-all “magic number” like $1 million or $2 million—it's figuring out the size investment portfolio you need to support the life you want.

Quick Formula - Using the "4% Rule"

The Retirement Number Formula:

Target Savings = (Annual Desired Spending - Guaranteed Annual Income) x Multiplier

Use a Multiplier of 25x for a standard 30-year retirement;

Use a Multiplier of 33x for early retirement (or if you are very risk averse).

Origin of the "4% Rule"

The 25x Multiplier is based on research conducted by William Bengen, a financial planner, in the early 1990s. In that research ("Determining Withdrawal Rates Using Historical Data", published in the October 1994 issue of the Journal of Financial Planning) he looked at stock and bond market data for rolling 30-year periods from 1926 to 1992 and asked a simple question: how much could a retiree withdraw from a portfolio of 50% stocks and 50% intermediate term U.S. Government bonds every year (adjusted for inflation) and never run out of money over a 30 year retirement? That period included major economic shocks like the Great Depression, World War II, the stagflation of the 1970s, and October 1987 "Black Monday". Based on that historical data he concluded that a retiree could safely withdraw 4% of the original portfolio adjusted for inflation each year. That is the origin of the so-called "4% Rule", or what Bill Bengen called the "SAFEMAX rate". Subsequently, a later study (Retirement Savings: Choosing a Withdrawal Rate that Is Sustainable) published in 1998 by three academic researchers at Trinity University confirmed Bill Bengen's conclusion.

Calculating Your Retirement Number - A Three-Step Formula

STEP 1: Define Your Vision (The Spending Target)

Many people believe you will need to spend about 80% of your pre-retirement income in retirement. While that very basic rule of thumb might work for some, there is no one-size-fits-all rule. Your number might be completely different.

The place to start is answering the question: What lifestyle do you want, and what do you truly need to spend to achieve the retirement lifestyle you desire?

• Low-Cost: Simple living, fixed expenses covered, minimal travel, or moving to low cost-of-living states (Mississippi, Oklahoma, Kansas, Missouri, Alabama) or countries (Vietnam, Indonesia, Thailand, Philippines, Malaysia, Ecuador, Mexico, Panama, eastern European countries). Read this article for more information on moving to low-cost countries.

• Comfortable: Steady travel, hobbies, and no budgeting stress.

• Luxury: World travel, maintaining two homes, and aggressive spending goals.

  
  

Your desired annual spending is your starting point.

Recommendation: Create a retirement budget from the bottom up. Use what you currently spend as a starting point. Make adjustments for things like eliminating your mortgage payment, kids leaving home, stopping retirement savings, increased travel, increased spending on hobbies, and rising healthcare expenses. If you are considering moving to a new state or a new country, you can use a tool like numbeo.com to help you develop a budget for that location. But you should definitely spend some time in that new location prior to moving there to validate your budget assumptions.

STEP 2: Calculate The Gap

Next, deduct all the guaranteed income that you will receive automatically, such as Social Security, pensions, annuities, or a TIPS bond ladder.

👉 Retirement Spending (Step 1) - Guaranteed Income = The Gap

The Gap is the amount your investment portfolio needs to cover every single year.

Example: You plan to spend $90,000 per year. Your guaranteed income is $40,000 per year.

👉 $90,000 - $40,000 = $50,000 Gap

STEP 3: Calculate Your Target Savings Goal

Now, multiply the Gap by a factor based on your risk tolerance and time horizon to calculate your savings goal. This is based on the 4% Rule (where 25 is the inverse of 4%) but adjusted for how long you expect to be retired and how much tolerance you have for risk during retirement.

Example: Your income-spending Gap is $50,000. For a typical 30-year retirement multiply that by 25 and your Target Savings is $1.25 million.

👉 $50,000 X 25 = $1,250,000 Target Savings

Multiplier	Target Savings	Best For ...
25x	$1.25 Million	A typical 30-year retirement (the standard safety baseline)
33x	$1.65 Million	Early retirement (longer time horizon) or a desire for very high safety
20x	$1.0 Million	Later retirement, flexible spending, or a plan to work part-time in retirement. Highest risk unless short retirement timeline or very flexible spending plan.

Note: These multipliers are the inverse of your Safe Withdrawal Rate (SWR). A 4% SWR equals a 25x multiplier; a 3% SWR equals a 33x multiplier; a 5% SWR equals a 20x multiplier.

Flexible Withdrawal Strategies Can Significantly Increase Withdrawal Rates

In the years since Bill Bengen introduced the so-called "4% Rule", various financial planners and researchers have developed a variety of somewhat more complex flexible spending strategies that can noticeably increase the safe withdrawal rate from 4% to as high as 5% or even 6%. These include the Vanguard Dynamic Spending Strategy, the Variable Percentage Withdrawal strategy, the RMD-based Spending Method, and the Guardrails Strategy.

The most common strategy is some variation on the Guyton-Klinger Guardrails Strategy originally developed in 2004 and formalized in 2006. Using the guardrails system, the retiree or financial planner monitors the relationship between the current size of the portfolio, withdrawals, and withdrawal rates and periodically adjusts the withdrawals up or down based on recent market and portfolio performance. So, when the portfolio does really well the retiree can increase his/her income by taking higher withdrawals. Conversely, when the portfolio does poorly the retiree must decrease his/her income by reducing withdrawals. Using this method, the initial withdrawal rate can increase to well over 5%, and typically retirees can withdraw more (in total) over a 30-year retirement using this method than using the more rigid "4% Rule". The downside is that withdrawals can be a bit more volatile (retirees much be willing to be a bit flexible in retirement), and retirees can find it a bit more complicated than the standard "4% Rule". Combining a flexible spending strategy with an income floor strategy can be a winning strategy for many retirees. Fortunately, some DIY financial planning software packages such as Boldin will calculate the guardrails for you and recommend any needed spending adjustments so that it is now quite easy to implement in practice.

Using these types of withdrawal and spending strategies can enable retirees to spend more in retirement or retire happily with a smaller nest egg to begin with. For example, if you assume that you can withdraw 5% using a guardrails strategy, then the required multiple used to calculate your nest egg is only 20x. Thus, a budgeted withdrawal of $40,000/year (adjusted for inflation) only requires an initial retirement portfolio of $800,000 rather than a portfolio of $1,000,000. That could mean retiring as much as 5-10 years earlier than with the "4% Rule".

Critical Bonus Tips (Don't Miss These!)

• INFLATION: You must assume your spending will rise by 3%-4% every year. Your portfolio must generate growth to offset this.

• HEALTHCARE: These costs are often underestimated. Factor in dedicated funds for rising premiums and potential long-term care. If you plan to live in the U.S., healthcare costs are projected to grow about 5-7% per year over the next 10 years.

THE BOTTOM LINE

Retirement planning isn't about chasing a magic number. It's about designing a resilient plan where your guaranteed income plus portfolio withdrawals keep pace with your desired lifestyle. Minimizing taxes is also important—see my blog post on asset location for helpful tips ("Reduce Taxes Through Proper Asset Location").

Taking Action Towards Your Retirement Goals

Ready to find your retirement number and build a plan to hit it? Would you like help stress-testing your retirement plan? Contact me or visit www.flourishingpathfinancial.com/book-online to book a free Discovery Session and get started!

Author: John Macy, MBA, RICP®

John Macy is a professional financial coach and the founder of FlourishingPath Financial Coaching. With over six years of experience as a financial coach, John helps pre-retirees and retirees design resilient portfolios and income streams for their next act. Read his full story here.