Are you concerned that you're not saving enough for retirement? Do you wish you could spend more today and enjoy life without this feeling hanging over your head that you should be saving that money instead. You may need less to retire than you think, and in this video I'm going to tell you why.
How Much The 4% Rule Says You Need So the big question is what's your magic number? How much do you need before you can punch the clock one last time and call it quits.
Well there's a million different ways to look at that, but by far the most common rule of thumb in the financial independence and retirement planning community is the 4% rule.
What the 4% rule says is that when you retire, you can withdraw 4% of your total portfolio balance in the first year of retirement, and you can increase that number each year by inflation. And if you do this for a 30-year retirement, according to the research this rule of thumb is based on, you can feel confident you won't run out of money.
So if you have a $1M portfolio, the 4% rule says you could take $40,000/year out of that portfolio, and increase that number annually by inflation.
So to answer the question of how much you need to retire, according to the 4% rule, you'd take your expected expenses in the first year of retirement and multiply it by 25. So if a couple retired at 65 and wanted to withdraw $75,000/year, which is right around the average American couple's annual expenses, according to the Bureau of Labor Statistics, then they would need $75,000 multiplied by 25, or $1,875,000.
Is The 4% Rule Too Conservative? For many people that feels like a really big number, especially when we're talking about supporting the average American's annual expenses. And it is almost certainly far more than you actually need.
The problem is, when you're starting from $0 or feel like you're behind, and you're told you need millions of dollars to retire, it's discouraging because that feels insurmountable. It makes sense that you would feel a pressure to save every marginal dollar. But when you look at the reality of the retirement picture, and see you may need less than you think, it gives you some freedom with what you do today. It allows you to enjoy today more and be more generous with your money.
But let's go over a few reasons why that fear is overblown.
How Social Security Factors In If you are plugging numbers into a retirement calculator online, it's pretty much guaranteed that they will ignore social security. And they do this because it complicates a simple calculator. But social security is a huge source of retirement income, and the most important source for many people.
I know there are questions about the future of social security and the funding gap, but it's going to continue to exist in some form for those of us in our working years.
Let me give you an idea of just how much social security changes the retirement picture. The average American household income was around $102k in 2023 according to the same Bureau of Labor Statistics Report I mentioned before. That's per household, not per household member, so let's just say we have a 40 year old couple and they will each make $50k this year. If we plug that in to the Social Security Administration's benefit estimator, we can see the estimated social security benefit per person depending on the age they start taking social security.
Now the first thing you may notice is how big the difference is between claiming at age 62 and claiming at age 70. You will get a pay raise for the rest of your life for every month you delay claiming social security from age 62 until 70. Waiting to claim your benefit can be one of the best ways to support a successful retirement.
So if both members of this couple delayed claiming social security until 70, which may not be the ideal choice, but that's for another video, if they did that, they would have nearly $5k/month in social security income. That's $60k/year. So for that couple that wants to spend $75k/year, there's now only a $15k/year gap, which they would need to fill with their investments from age 70 on. So if we take the 4% rule at age 70 with the $15k/year they need from their investments, then $15k * 25 = $375k. At age 70, their investment portfolio would need to be $375k to support their lifestyle.
How Do You Bridge The Gap Before Social Security? What if they wanted to retire before age 70? Then their investments would need to bridge that gap until they claim social security. Let's say this couple wanted to retire at 65 and just be conservative here, we'll say their investments from age 65 to 70 grow at the pace of inflation, but nothing more. Then to cover the 5 years before social security, they would need 5 years of annual expenses saved. 5 * 75,000 = $375k. So if we take the $375k they need for the 5 years before social security, plus the $375k they need at 70, then the total they would need to retire at 65 is $750k. That's much easier to stomach than the $1.875 million we said would be needed if we ignored social security.
To get $750k saved by age 65, this couple would need to save around 11% of their $100k income for 30 years and earn a 5% real return. Real return meaning the return on top of inflation. This would include employer 401k matching contributions, so I think this is achievable for many people.
What Are Other Ways To Lower The Amount You Need To Retire? Alright, so if you’re still feeling like the retirement numbers are out of reach, here are four more reasons you may need less than you think, which I hope can ease your mind and show you that retiring might be more achievable than you think.
1. Semi-Retirement Remember, retirement doesn’t have to mean a full stop on earning money. A lot of people opt for a semi-retirement where they work part-time or freelance and earn some extra money. This not only supplements your income but also keeps you engaged and active. Every dollar you earn in part-time income reduces what you need to withdraw from your investments. Which means you need less invested in the first place.
2. The Retirement Spending Smile You might have heard of the "retirement spending smile." In simple terms, the retirement spending smile describes the shape of the typical retiree's spending throughout retirement. Most retirees' don't spend the same amount each year throughout retirement. Usually, expenses are higher in the early years, and then drop during mid-retirement as the retirees energy and mobility drops, and sometimes pick up in the last few years for health-related reasons. Overall, though, your average spending throughout a full retirement can be lower than you initially assume or than you plan to spend in the first few years. This natural dip means your portfolio might stretch further than a static 4% rule suggests.
3. Dynamic Spending By dynamic spending, I mean being flexible with your expenses. The ability to cut back in years where your investments are down has a really big impact on the longevity of your investments. This means that your planned retirement expenses can't be the barebones basic necessities. There needs to be some cushion there which means you could cut back on a few things if your investments aren't doing well. By having this flexibility, the average safe withdrawal rate across your retirement could potentially be extended beyond 4%.
4. Home equity If you own a home, there's a high liklihood that it's one of your biggest assets. Many retirees have significant equity built up in their home, which can be tapped into in retirement. Whether that's through downsizing, a reverse mortgage, or a home equity line of credit, tapping into your home’s value can provide an extra cushion, which again, most people completely ignore.
Summary Now it's important to recognize that many people aren’t saving as much as they should for retirement. However, there are also a lot of people that feel like they aren't saving enough, but in reality are doing just fine. When you factor in things like Social Security, potential part-time income, natural retirement spending patterns, flexible spending strategies, and even home equity, the retirement gap might not be as wide as you think.
This is where a plan can be really valuable. Think of it as a roadmap that ties together every aspect of your retirement strategy. It helps you see the full picture and understand whether you're on track, and if not, what you need to do to get there. Ultimately, a well-crafted financial plan allows you to confidently balance enjoying life today and preparing for tomorrow.
If you've never worked with a financial planner before, then reach out to me and I can help. Scan the QR code or click on the link below for a free planning session where we can see what's possible.
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