Let's make some casual, back-of-the-napkin maths to understand the amount of income required to make your dream a reality. Write down the amount you spent in the last year. If you spend $35,000 to sustain your life, you'll require an annual income of $35,000 starting at the age of 56. If you have spent $100,000 in the last year, $200,000, $250,000, or a different amount this year, that's the amount you'll require.
This assumes that the lifestyle you'd like to live next year is the same one you had the previous year, and you'll need enough savings and other sources of income to cover your expenses after you reach your full retirement age of 66. However, it does not include the factors that can impact your expenditure in a drastic manner, whether pleasant (a travel experience) or not so pleasant (a serious health issue).
How Much Savings Do You Need?
If you die, then the stream of income earned is cut off. What savings are you required to cover your expenses? All else being equal, you'll need to be able to keep 10 times your expenses saved to earn enough income to support your family until you start receiving Social Security benefits at the age of 66.
The Government's Role
What if you glance at those numbers and think about it and realize that you do not have enough money to afford your lifestyle for the next decade while still paying your expenses. Yet, you want to retire at the age of 56. This leads us to the second back-of-the-napkin analysis of how much you'll need at the beginning of your retirement.
Start by making the simplest assumption for 66 years old: Social Security will be your sole source of income in retirement. You began working at the age of 20. You are eligible for the highest amount of Social Security benefits. In this case, an individual who retires in 2021 can get a maximum of $3,895 a month. This is equivalent to $46,740 per year.
Let's say you earn a minimum average annual salary of $46740. Based on that calculation, it would require $467400 to cover your expenses for the next decade before your first check for benefits arrives. Naturally, you may opt to begin receiving Social Security benefits a bit earlier, around the age of 62. This will drastically reduce the number of payments, however.
How Much Money Can You Take From Your Savings Every Year?
According to a study, an investor who has a portfolio comprising 50 percent bonds and 50 percent stocks could take 4 percent out of the portfolio during the first year and alter the amount to be withdrawn by increasing inflation every following year without the risk of running dry of funds before the time of death.
If, for instance, you have savings of $250,000, you can withdraw $10,000 in the initial year, then adjust that amount to increase for inflation every year over the following 30 years. The higher rates of withdrawal that start above 7 percent per year greatly increase the chance that your portfolio will be depleted in 30 years.
More recent studies regarding the four percent rule indicated that you could improve the Trinity results by making small adjustments. For instance, you should avoid pulling money from your savings account during a bear market year, for example, or avoid the inflation "raises" for several years at each period. At first, it's best to take care when withdrawing money from your savings account when you can.
4.5% is incredibly sensible for the majority of people. A one million nesting place for retirement will bring in $40,000 annually in earnings. Many people find that taking a little longer to work will assist in closing the gap in savings. In addition, you'll keep earning an income. Still, you'll also benefit from a delay in Social Security benefits, which will increase every year you are waiting for 8 percent in the time between your fully retired ages to 70.
Conclusion
Naturally, the assumptions made do not represent the reality of a complicated world. Although the basic math is straightforward to calculate, it doesn't include the variables of returns on investments, the rising price of living, unanticipated medical expenses, and a myriad of other elements and possible modifications to how you spend money on your lifestyle. In the end, you'll need to have substantial savings to cover the gap up to the time that Social Security kicks in.
