1Consumer Price Index, 1920 to 2019, U.S. Department of Labor Bureau of Labor Statistics
2This hypothetical example is used for illustrative purposes only. Actual results will vary.
How Much Annual Retirement Income Will You Need?
How much annual income will you need in retirement? If you aren't able to answer
this question, you're not ready to make a decision about retiring. And, if it's
been more than a year since you've thought about it, it's time to revisit your calculations.
Your whole retirement income plan starts with your target annual income, and there
are a significant number of factors to consider; start out with a poor estimate
of your needs, and your plan is off-track before you've even begun.
It's common to discuss desired annual retirement income as a percentage of your
current income. Depending on whom you're talking to, that percentage could be anywhere
from 60% to 90%, or even more, of your current income. The appeal of this approach
lies in its simplicity, and the fact that there's a fairly common-sense analysis
underlying it: Your current income sustains your present lifestyle, so taking that
income and reducing it by a specific percentage to reflect the fact that there will
be certain expenses you'll no longer be liable for (e.g., payroll taxes) will, theoretically,
allow you to sustain your current lifestyle.
The problem with this approach is that it doesn't account for your specific situation.
If you intend to travel extensively in retirement, for example, you might easily
need 100% (or more) of your current income to get by. It's fine to use a percentage
of your current income as a benchmark, but it's worth going through all of your
current expenses in detail, and really thinking about how those expenses will change
over time as you transition into retirement.
Factors to consider
It all starts with your plans for retirement — the lifestyle that you envision. Do
you expect to travel extensively? Take up or rediscover a hobby? Do you plan to
take classes? Whatever your plan, try to assign a corresponding dollar cost. Other
specific considerations include:
- Housing costs: If your mortgage isn't already paid off, will it be paid soon? Do
you plan to relocate to a less (or more) expensive area? Downsize?
- Work-related expenses: You're likely to eliminate some costs associated with your
current job (for example, commuting, clothing, dry cleaning, retirement savings
contributions), in addition to payroll taxes.
- Health care: Health-care costs can have a significant impact on your retirement
finances (this can be particularly true in the early years if you retire before
you're eligible for Medicare).
- Long-term care costs: The potential costs involved in an extended nursing home stay
can be catastrophic.
- Entertainment: It's not uncommon to see an increase in general entertainment expenses
like dining out.
- Children/parents: Are you responsible financially for family members? Could that
change in future years?
- Gifting: Do you plan on making gifts to family members or a favorite charity? Do
you want to ensure that funds are left to your heirs at your death?
Accounting for inflation
Inflation is the risk that the purchasing power of a dollar will decline over time,
due to the rising cost of goods and services. If inflation runs at its historical
long-term average of about 3%, a given sum of money will lose half its purchasing power in
about 23 years.1
Assuming a consistent annual inflation rate of 3%, and excluding taxes and investment
returns in general, if $50,000 satisfies your retirement income needs in the first
year of retirement, you'll need $51,500 of income the next year to meet the same
income needs. In 10 years, you'll need about $67,196. In other words, all other
things being equal, inflation means that you'll need more income each year just
to keep pace.2
How much will you need to equal $50,000 in today's dollars given 3% inflation?