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Thayer Partners Blog

How Much Money Do You Need to Retire?

[fa icon="calendar"] Sep 5, 2016 9:00:00 AM / by Chris Wilmerding

Chris Wilmerding

How_Much_Money_Do_You_Need_to_Retire.jpgIt’s the age-old question every working American has asked at one time or another: how much money will I need to retire? Understanding the answer to this question can make or break your retirement savings plans. Many fail to save as much as they should because they think they need much less or because they are confronted with more urgent and immediate needs for cash. As a result, they struggle to make due after they retire.

But forecasting your financial retirement needs doesn’t have to be tough. In fact, when you use the 4 Factors Model, you can get a pretty good estimate, which you can use to start budgeting for retirement.

The 4 Factors Model

There are four main factors that you need to consider when calculating how much you’ll need to save to retire comfortably: non-discretionary spending, discretionary spending, inflation, and life expectancy. Though using the 4 Factors Model won’t give you an exact answer (because really, who knows their life expectancy to the day?), it can help you to get a ballpark number, which you can then use to create realistic retirement goals and create a preliminary budget.

Your Daily Living Expenses (Non-Discretionary)

Your non-discretionary spending consists of your basic living expenses, such as food, shelter, gas, medication, and utilities. Consider where you’ll be living: if you plan to move to a less expensive area, these costs could be reduced.

In this category, you’ll also need to consider any debt that you’ll be carrying forward into your retirement. Do you expect to have your mortgage, credit card debt, student loans? Will car loans be paid off by then, or should you factor in these payments?

Another part of non-discretionary spending to consider includes your healthcare costs and insurance expenses. Will you be buying long-term-care insurance just in case you get ill as you grow older? Will you purchase and pay for life insurance?

The Fun Stuff (Discretionary)

If you only think about your basic living expenses when calculating how much you’ll need to retire, you’ll find yourself running out of money quickly. It isn’t realistic to think that you won’t spend money on other non-necessities, too. This type of discretionary spending covers internet and television, travel expenses, golf or other hobbies, and any other fun stuff you plan to do or any extra money you plan to spend.

Remember to calculate both discretionary and non-discretionary spending after taxes.

Don’t Forget about Inflation

Don’t make the mistake of forgetting about inflation. Once you retire in 10, 20, or 30 years, the cost of pretty much everything will be much higher than it is now. You have to factor this in. The average rate of inflation is 3.22% a year, so increase all of your costs by this much per year to be safe. And don’t forget to factor in the impact of inflation while you are in retirement. Most folks will be retired for 20 or more years.

Life Expectancy

OK, you can’t realistically know how long you’re going to live, so you can’t really ensure that your investment income will be able to support you for as long as you live. Since you don’t have a crystal ball to figure this one out, your best bet is to be conservative yet realistic in your estimate. Consider the average life expectancy in the US and go from there.

Now Put It All Together

Now that you’ve calculated your discretionary and non-discretionary spending, taken inflation into account, and given yourself a rough estimate of your life expectancy, you should have some realistic numbers that you can use to start saving for retirement. Now, it’s time to figure out where that income will come from: deduct any inheritance, your Social Security benefits, your pension income, and all other income buckets, and you’ll come up with the amount of money that you’ll need to save to retire.

How Much Do I Need to Retire?

Topics: Saving For Retirement

Chris Wilmerding

Written by Chris Wilmerding

Chris Wilmerding is Principal of Thayer Partners, an independent investment management firm located in Westwood, MA providing financial planning and wealth management counsel to individuals and their families.

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