Posts Tagged ‘income

09
Mar
12

You only need between 0.1% and 200% of your current income to retire

That’s our guess, and it should cover almost everyone, with a few outliers.

But the question of “how much money do you need based on current income” is an interesting and very complex question.  More specifically, a reader on one of our favorite blügs, Grumpy rumblings of the untenured, asked how much moolah does one need (and they wanted to know based on % of income)?

Well, there are rules of thumb (or heuristics as the Grumpies call them).  And you can read every financial magazine and blüg to your heart’s content.  Some will say 90%, some will say 100% (yikes!) and others will say 70%.  So on and so forth.  Applying their rules of thumb, a couple with a pre-retirement income of $50k will need their portfolio to yield anywhere from $35k to $50k annually.  If you’re lucky, this all works out for you.

We don’t like the percent of income approach.  Here is why:

  • Your taxes will be less in retirement.  Ok, we don’t wish to invoke a religious war (yet, we have a post coming up on future tax rates in retirement, our tea leaves were strong this morning), but generally speaking if someone retired today, they would be paying less in tax.  How?  First, you don’t have to pay that nasty Social Security and Medicare tax.  Second, if you were in, for example, the 25% marginal tax bracket pre-retirement, you could drop down into the next marginal tax bracket.  Or, if you are taking dividends and capital gains, currently that is only 15%.
  • You are no longer saving for retirement (because you are doing it!).  So, if you saved 15% of your gross income pre-retirement for retirement, that is 15% of your gross income you don’t need in retirement.  Or someone who arrived late to the saving-for-retirement party may save 50% of their gross income.  Or someone who wants to retire early may have a high savings rate as well.
  • Your pre-retirement expenses do not equal your retirement expenses.  Generally speaking, most people’s expenses will go down.  There are some basic needs people need to cover first – shelter, food, utilities etc.  And covering your basic needs will more than likely be less than your current income (at least we hope so, or retirement is the least of your worries).  Then there are expenses of having to go to work everyday – more miles on a vehicle, gasoline (have you noticed gasoline prices are rising?), clothes for work, eating out at lunch, dry cleaning etc.  In retirement, maybe you pick up your dawg’s poop from the yard instead of paying the neighbor’s kid to do it?  And with your new found time, maybe you fix the leaky toilet instead of hiring a plumber (this may not result in cost savings if your spouse is anything like mine!).  You  also won’t need those life insurance policies (unless you have some expensive estate planning tactic up your sleeve).  But, some things can increase your retirement expenses.  Maybe you want travel the world or pick up an expensive hobby (like fast cars and fast ______)?  Don’t even get us started on health insurance…

There are many variables which can have a huge impact.  Each person is unique.

What we suggest is to track every penny of your current expenses to help you form a retirement budget.  Not only will it show you the cost for your quality of life (generally, most people find some fat to cut out) but, it helps with solving the riddle of how much moolah you need in retirement.  Tracking your expenses will show the cost of your basic needs, it will show you things you won’t need to spend money on in retirement – like SS tax (We know you’ll miss that!), work expenses etc – and it will help you determine how much you want to spend for your retirement goals.  It can be difficult to forecast expenses for your retirement goals, since you may not see them fully represented in your expenses right now, but making an educated guess is better than ignoring them.  Tracking your expenses over multiple years also gives you an idea of the cost of less frequent events, such as home maintenance or tires for the car or whatever surprises life throws at you, which should also put into your retirement budget.

What we like most about this approach, is you more precisely know your income needs in retirement (also accounting for your retirement goals).  And you are highly unlikely to ever have to do the durdiest of durds, eat cat food go back to work, because your basic, everyday, bare bones living expenses should be less than your planned retirement income needs.  Meaning, you can tighten your belt and leave out that trip to Vegas with the gurls when life pees on your favorite tree.

So, doing this exercise of forecasting your current expenses into a retirement budget, do you find your retirement income needs are within the rule of thumb heuristic of 70% to 100% of gross pre-retirement income?  Or are you less?  What say ye?

Now, this only covers how much annual income you will need in retirement.  We’ll get to how you translate that into a total savings dollar value in another post…down the road…sometime.

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