Wondering how much you need to save for retirement?
The math isn’t exactly rocket science. But you do need to understand the concept of safe withdrawal rates to run the numbers.
Here’s a quick overview, along with a withdrawal rate in retirement calculator to run numbers quickly.
What Are Safe Withdrawal Rates for Retirement?
While safe withdrawal rates sound complicated, they’re actually pretty simple.
A safe withdrawal rate is what percentage of your retirement portfolio you can pull out every year to live on, without running out of money before you croak (called “superannuation” by finance nerds). The more you pull out every year, the faster you’ll burn through your money. Not exactly rocket science, right?
So, one question is how long you want your nest egg to last. If you only plan on living for ten years after retiring, then you can burn through your nest egg much faster than someone who wants it to last for 30 years, or 50 years, or indefinitely.
Which brings us to the classic safe withdrawal rate that you may already be familiar with: the 4% Rule of retirement planning.
The 4% Rule in Retirement
Rewind to the ’90s when a financial planner named Bill Bengen ran an interesting study: he analyzed stock market data from the previous 75 years and found that if retirees withdraw 4.2% of their nest egg each year, mathematically their savings is nearly certain to outlive them. This became simplified to the 4% Rule: retirees can pull out 4% of their savings each year to live on, and their savings should last at least 30 years.
Imagine the first year of your retirement earns an average historical stock market return of 10%. You pull out 4%, so your portfolio still sees a 6% rise in value.
In this average-year example, your portfolio still rises in value by 6%! You can live forever on that nest egg, right?
On paper, yes. The problem is the stock market doesn’t rise by a uniform 10% each year: it drops by 23% one year, surges by 35% another year, and wobbles its way upward by 8% the next year. This volatility poses a threat called sequence risk — the risk that the stock market will crash within your first 5-10 years of retirement, depleting your portfolio to the point that it can’t recover, even after stocks bounce back up again.
Fortunately, you have plenty of options for mitigating sequence risk. They share one thing in common: they’re all income-producing investments that don’t require you to sell off stocks in order to pay your bills. Options include rental properties (more on that shortly), dividend-paying stocks, bonds, private notes, real estate crowdfunding investments, REITs, and any other income-producing assets.
How Inflation Impacts Safe Withdrawal Rates
“Whoa there, what about inflation? That $40,000 won’t be worth as much in ten years from now!”
The 4% withdrawal rate applies to the first year of retirement. After that, you simply adjust the annual withdrawals to keep pace with the higher cost of living.
Let’s say Heidi wants $40,000 each year in retirement income. She plans on following the 4% Rule in retirement. So, she divides 100% / 4% and reaches a multiplier of 25. She then just multiplies $40,000 by 25 to reach a target nest egg of $1,000,000.
She reaches her goal of $1 million, retires, and withdraws $40,000 in her first year of retirement.
In her second year of retirement, the inflation rate is 2%, so she adds 2% to her annual withdrawals. Instead of pulling out $40,000 in Year 2, she pulls out $40,800. In Year 3, the rate of inflation hits 3%, so she tacks on another 3% to her previous year’s withdrawals. That puts her annual withdrawal at $42,024. And so it goes, as she adjusts her withdrawals for higher living expenses based on the annual rate of inflation.
Meanwhile her stock portfolio continues to grow — at least when the market rises. Maybe the stock market crashed 18%. Or maybe it surged 26%. But over time, she pulls out far less than the average market return, which is why the 4% rule of thumb works.
Does the 4% Rule Hold Up in Today’s Economy?
Bengen ran his analysis back in the ‘90s. You may have noticed that a few things have changed in the economy since then — particularly interest rates being held low for basically this whole century to date.
That begs a few questions, such as:
“Does this 4% Rule even guarantee me those 30 years? It sounds like I could run out even before then!”
“What if I want to retire young? What if I want my nest egg to last 50 years, not 30 years?”
Excellent questions. First, you can take comfort in the fact that over the last 150 years, there has not been a single 30-year stretch when someone following the 4% Rule would have run out of money in under 30 years. Financial planner Michael Kitces ran those numbers, not me — rest at ease.
Kitces also calculated that you don’t have to reduce your withdrawal rate by much, in order to make your nest egg last forever rather than just a minimum of 30 years. Instead of following the 4% Rule for retirement planning, just set your initial withdrawal rate at 3.5%. Based on historical data, your portfolio should continue rising forever, because you’re withdrawing so much less than the returns.
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How Much Do You Need to Retire?
Before you can calculate how much you need to save for retirement, you need to know how much income you want in retirement. If you want $100,000 per year in retirement income, you need a lot more than if you only want $40,000.
Note that your annual retirement spending is not the same thing as your current annual income. Treating the spending and income similarly is exactly why most people don’t retire young: they spend nearly as much as they earn.
Say you’re following the 4% Rule. To know how much you need in retirement savings, you simply multiply your annual spending by 25. The reasoning is simple: 4% X 25 = 100% (your total nest egg). If your annual spending is $40,000, then you need a nest egg of $1 million, if you want to withdraw 4% ($40,000) in the first year of retirement.
Alternatively, if you’re following a 3.5% withdrawal rate, then you need to multiply your annual spending by 28.6 rather than 25. Why? Because 100% / 3.5 = 28.6. Using a 3.5% withdrawal rate, you’d need $1,142,857 to produce $40,000/year in income, rather than the $1,000,000 you’d need if withdrawing 4%.
To help you choose a withdrawal rate for retirement, check out this chart showing how long your nest egg is likely to last, based on your withdrawal rate:
|Length of Time||3%||4%||5%||6%||7%||8%||9%||10%|
Those numbers are based on an historical analysis of the last 90 years by Wade Pfau. He assumed an asset allocation of 75% stocks, 25% bonds.
Withdrawal Rates in Retirement Calculator
So how much do you need to save for retirement, based on your target withdrawal rate?
Plug your target annual income and withdrawal rate in retirement into this calculator:
It’s pretty simple math, but a withdrawal rate in retirement calculator still lets you play around with different numbers easily.
Still, most real estate investors combine many streams of income in retirement, rather than just pulling money out of their portfolio of paper assets. Check out this FIRE calculator to take both real estate investments and paper assets into account for your retirement planning.
How Long Will It Take Me to Save Enough to Retire?
We ran those numbers for you, because we’re thoughtful like that.
They require a few assumptions however:
- You’ll earn a long-term average return of 10% on your investments, and
- You’ll follow the 4% Rule in retirement.
Here’s how long it will take you to retire, depending on your savings rate (I used an income of $100,000 as an example, but the savings rate and years are the same regardless of the income):
|Savings Rate||Monthly Savings||Monthly Living Expenses||Target Annual Income||Target Nest Egg||Years to Reach|
Check out the full breakdown of how much you need to save to retire quickly.
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Combining Passive Income Streams
Ideally, you want to combine many streams of income in retirement. Some income might come from Social Security, depending on when you plan to retire. If you plan to retire early, Social Security won’t help, at least not until you reach your 60s and start collecting it.
Most retirees use an asset allocation that only partially involves stocks. Bill Bengen assumed an asset allocation of 60% stocks, 40% bonds. If you’re worried about a stock market crash, you can always diversify for an even more balanced portfolio. An investment portfolio that includes, say, real estate!
Start brainstorming sources of passive income to live on in retirement. They can include dividend-paying stocks and ETFs and bonds of course. I personally invest in real estate as an alternative to bonds, because it generates higher investment returns.
But that doesn’t mean you shouldn’t invest in growth stocks as well, and sell off a portion of your portfolio each year in retirement. For the portion of your portfolio that requires you to withdraw money, you can use the retirement withdrawal rate calculator above.
Sample Retirement Income Streams
Say you want $60,000 per year in retirement income. That breaks down to $5,000 per month.
If I wanted $5,000 a month in retirement income, I might string it together like this:
- $1,000 in net rental cash flow (ideally no more than 2-3 units)
- $1,000 in stock dividend ETFs or mutual funds
- $1,000 in selling off growth stocks
- $750 in real estate debt crowdfunding income (such as platforms like Groundfloor and Concreit)
- $750 in real estate equity crowdfunding income (such as platforms like Fundrise and Streitwise)
- $500 in municipal bonds and corporate bonds
So how much would you need invested in each type of investment, to reach these numbers?
While hardly written in stone, here are some reasonable approximations:
- $250,000 invested in rental properties (earning a cash-on-cash return of 9-10%, although you could just reuse the same $50,000 down payment if you use the BRRRR method)
- $300,000 invested in high-dividend funds (earning an average dividend yield of 4%)
- $343,000 invested in growth stock funds (at a 3.5% withdrawal rate)
- $120,000 invested in real estate debt crowdfunding (earning an average yield of 7.5%)
- $120,000 invested in real estate equity crowdfunding (earning an average return of 7.5%)
- $240,000 invested in bonds (earning an average yield of 5%)
That’s a total of $1,373,000. Hardly chump change, but still better than the $1.5 million you’d need if you just followed the 4% Rule.
Before you quit your day job, speak with a financial advisor or two to make sure you didn’t overlook anything that might, you know, lead to you living on the streets in your old age. Most investment advisors aren’t real estate investors however, so take their advice about real estate with a grain of salt. Better yet, speak with a financial advisor with real estate experience.
The best part about reaching financial independence and early retirement isn’t the ability to do nothing. It’s the ability to do anything.
You can still work when and how you want, bringing in some extra income in the process so that you don’t need an enormous nest egg. When you don’t need a job with a huge salary, you can go do whatever makes you happy… and still get paid for it. Do freelance work. Teach a college course. Volunteer or add pro bono work to the mix. Travel and blog about it. Work at a winery a few days each week.
Retiring young doesn’t mean never working again, it just means being financially independent enough that you don’t need a high-octane job to pay your bills. By creating a diversified investment portfolio, following the 4% Rule for retirement or perhaps 3.5% safe withdrawal rate for your stocks and a few well-chosen rental investments, you can retire far younger than you think.♦
When do you hope to retire? What are you planning for a withdrawal rate in retirement?
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About the Author
G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.