Question: How much saving do I need for $50,000 retirement income for 25 years in addition to my Social Security checks?

Answer: There is no perfect answer to this question.  The answer depends on your investment allocations, investment costs, future inflation, future market performance, and future tax rates.  None of us know what the future will be, so we assume that the future will be like the past.  This can be a very bad assumption, so any forecaster should emphasize this point.

In the answer below, we’re going to assume that you are already close to retirement.  If not, you’ll need to increase amounts to account for inflation until you retire.  For example, if the answer is $1 million in today’s dollar values, then in ten years you would need 1.34 times as much with 3% inflation per year or 1.48 times as much for 4% inflation.  In twenty years till retirement you would need 1.89 times as much at 3% or 2.19 times as much at 4%.

It’s often common for financial sales people to say how you can be a millionaire if you save relatively small amounts of money over long periods.  They (intentionally) fail to point out that a million dollars in the future will be far short of what a million dollars is worth today.  So, not being a financial sales person, I’m telling you in advance that the results below are all in today’s dollar values.  You’ll need to increase these amounts by inflation for each year between now and retirement.

The bottom line is that there is a very simple way to get a ballpark answer to the savings question:  How much savings do I need for $50,000 retirement income for 25 years?  That’s to multiply the before-tax income times the number of years of retirement, e.g., $50,000 x 25 = $1,250,000.  If your financial source says that you need only a fraction of that result, start asking a lot more questions.

OK, let’s do a more refined analysis using the Free Pre Retirement Planner from www.analyzenow.com.  That planner lets you distinguish between deferred-tax investments, taxable investments and tax-exempt investments, but we’re going to just consider deferred-tax investments here, that is, investments in an employer’s savings plan or IRA.  Most likely you would need less in taxable investments and tax-exempt investments when considering after-tax income.

If you have a retirement allocation of 40% stocks, 50% bonds and 10% money markets along with investment costs of 1.5% (very common), and if future inflation would be 4%, you would need $1,120,000 savings at retirement.  That assumes use of long-term market index averages for each of the three retirement investments.  It also accounts for reverse-dollar-cost-averaging that are a consequence of regular withdrawals as well as investment costs.  You can reduce the amount you need by using index funds with costs of only 0.2%.  Then you need $950,000 or 15% less.  You would need more if you thought there was a reasonable chance of living longer than 25 years.

You also might need less with a higher allocation of stocks, but you incur significantly more risk, especially if you have a couple of bad years of stock returns earlier in retirement.  That’s what happened to those who retired in 1965 like my father.  It’s also what happened to those who retired near 2000 like a number of my younger friends.  The Free Retirement Planner gives you an idea of the amount of this risk by showing you the income you would get (1) with your own assumptions for returns and inflation, (2) the returns and inflation for the years that followed 1965 and (3) the returns and inflation that followed 1948.  Unlike the poor performance following a 1965 retirement, 1948 was one of the very best years to have retired because security markets really flourished early in retirement.

The Free Pre Retirement Planner shows that those who retired in 1965 would have used up the entire $950,000 in 25 years if they only spent $15,000 a year, not $50,000.  On the other hand, it shows that they could have spent $108,000 if they had retired in 1948.  This difference is staggering.  All of this with only 40% stock allocation.  Also those who retired in 1965 had higher taxes than those who retired in 1948 thus delivering another crippling blow.

It is important to understand that inflation plays a very large part in these results.  Virtually all retirement planners assume that expenses will go up every year with inflation.   (The Dynamic program on www.analyzenow.com is an exception.  It makes an entirely new calculation of affordable expenses each year instead of assuming a simple inflation adjustment.)  Most planners use a default value of 3% inflation to represent the inflation results including the Great Depression.  The average inflation starting right after the Great Depression is about 4%.  Inflation in the first twenty years of a 1965 retiree was 6.3%.  Even with retirement in 1948, the first twenty years of inflation was 4.3%.  That’s why I don’t like to see people use historical returns along with 3% inflation.

So maybe just multiplying the number of years you might live in retirement times the pre-tax income you want is not a bad idea.  It’s slightly more conservative than using average returns and inflation, but not as safe as using the economics following 1965.  That is, if the future returns, inflation and taxes are like those of the past.