How much do you need to save for retirement? Why you need a 401(k)...

 

I think this is the question I get asked most frequently. The answer is complicated. This is where an hourly CFP might come in handy.  However, if you just want a “back of the napkin” calculation, I can provide you with a commonly used formula.  Many people believe that you can safely withdraw 4%, each year, from your nest egg, and probably never run out of money.  There is a lot of debate on this subject but I’ll go ahead and use the 4% withdraw rule in our example. I'll show you where to test the rule at the end of this blog.

First thing’s first, you need to figure out how much PERA pension you’ll receive each year. Go through the blog post that I wrote a few days ago and write down the monthly salary that you will receive. Multiply it by 12 months to get your yearly PERA salary.  If your spouse is a teacher, you’ll need to do the same for him/her and add the two numbers together.

Let’s pretend that that my monthly pension will be $3,333 x 12 months = $40,000/yr. 

If you or your spouse is expecting social security, you’ll need to use the social security website to get an estimate of your yearly benefits. Remember, teachers who have paid into social security will get a reduced social security benefit. Since neither my wife nor I are expecting much social security, I’m not going to include it in our calculations.

Next, you need to determine your yearly spending. This is a very difficult calculation and you may need to estimate it for now. Major expenses to consider are health insurance, mortgage/rent, transportation, food, insurance, taxes, vacation, college tuition, entertainment, etc.  I am expecting health insurance to be our biggest expense, until we qualify for Medicare. The PERA website estimates that health insurance will cost my family between $18k/yr to $36k/yr. This number in unbelievably large and illustrates the looming health care crisis this country faces. Currently, our family of four is thriving on less than $70k/yr in spending (we save the rest for retirement). This doesn’t include future health insurance though. However, our home should be paid off by the time we retire and the money we currently spend on the mortgage will be enough to cover our future health insurance expenses.

Okay, let’s say that I’ve come up with a number of $75,000/yr in spending.  That’s seems like a lot but remember, I can subtract our yearly pension(s) and social security benefit(s).

$75,000 yearly spending - $40,000 in PERA pension = $35,000/yr to make up the difference.

Once you know the amount you need, to make up the difference, you can determine how much you’ll need to save for retirement. How? Remember the 4% rule? Because we are using the 4% rule, we can simply multiply the number we need to make up by 25.

$35,000/yr (the amount we need to make up) * 25 = $875,000.

So, in this example, my wife and I would need to save $875k in our investment accounts.  That’s a lot of money and that’s where your Roth IRAs and 401(k) should come in! Hopefully, your spouse will receive social security benefits or have their own pension. If this is the case, your number will be much smaller.  Many people sell and downsize their home in retirement too. This could add a large sum of money to your nest egg. If you started late, or haven’t saved enough, you may need to work longer.  Once you hit the age of 65, you will be eligible for Medicare and this will bring your yearly spending down significantly.

As I said before, this is a very rough estimate. For example, it doesn't fully address inflation and PERA's cost of living adjustment. Currently, the PERA pension includes a 1.5% cost of living adjustment after three years in retirement. This probably isn't enough to cover inflation and may go away altogether. It would be worth paying an hourly CFP to help you make this calculation. There is a very useful website called FireCalc https://www.firecalc.com/ that will run your numbers through hundreds of scenarios and then tell you the success rate of your plan.  Using the numbers above, for a 30 year retirement, FireCalc determined a 95% success rate of not running out of money in retirement. For a 40 year retirement, the success rate dropped down to 85% (shown below). So, the 4% rule isn't perfect but it will get you in the "ball park."

Nothing presented is to be construed as investment advice. Investment advice can be secured from a vetted Certified Financial Planner (CFP®).

When working with a CFP®, it is recommended that s/he sign a Fiduciary Pledge. More information, including questions to ask a planner and a downloadable Fiduciary Pledge, can be found here: https://403bwise.org/education/professional