Playing golf at the club every day. Booking a round-the-world plane ticket. Spoiling your grandchildren with trips to the zoo and three scoops of ice cream. Regardless of how you plan on spending your retirement, the question of “When can I retire?” is probably on your mind.
However, there’s another question to ask: How much do you need to save to retire?
It might seem like there’s an overwhelming number of factors to consider. Retired people worry about Social Security, inflation, and health care costs—but these all might boil down to: “How much can I safely spend without running out of money?”
Thankfully, there is a formula for calculating these costs that can help with planning for the future. But it all starts by deciding at what age you want to retire, and how that decision affects your finances.
When Can Retiring With Full Benefits Happen?
Before diving into the savings formula, let’s look at the basics. When does the government say people can retire and receive full Social Security benefits, and at what age can people start withdrawing from their retirement accounts without facing penalties?
For Social Security, the rules go by birth year. For example, people born in or before 1937 could have retired with full Social Security benefits at age 65, those born in 1938 could retire at age 65 and two months, and those born in 1939 could retire at age 65 and four months. The Social Security Administration’s most recent update states that those born in or after 1960, can retire at age 67. The SSA’s chart is here for more information.
Now let’s look at retirement accounts. Each type of account has different rules about when money can be taken out.
If a Roth IRA account has existed for at least five years, withdrawals from the account are usually okay after age 59½ without consequences. Taking out money earlier or withdrawing money from a Roth IRA that’s been open for fewer than five years could result in paying penalties and/or taxes.
People with a traditional IRA can make withdrawals from ages 59½ to 70 without being penalized. People with 401(k)s can typically retire by age 55 and make withdrawals without receiving a penalty.
There is a little wiggle room. Retirement withdrawal rules do have exceptions for issues like disability or educational expenses, and there is an option to withdraw money early and pay taxes or penalties. Receiving Social Security benefits as early as age 62 or as late as 70 are options, but that decision will affect how much money is received per month.
What About Retiring Early or Late?
When it comes to Social Security, a recipient will be penalized if they retire before full retirement age. The earlier a person retires, the less they’ll receive in Social Security. Let’s use John Doe as an example and say he was born in 1960, so full retirement age is 67.
If he retires at age 66 and 11 months, he’ll receive 99.4% of Social Security benefits; age 66 and 10 months will get John 98.9%. If he retires on his 62nd birthday, he’ll only receive 70% of earnings. This is the price of receiving Social Security for a longer amount of time.
There is also the option of retiring before age 62, but Social Security benefits won’t kick in until age 62. These are all factors that could be considered when deciding when to retire.
If a person wants to keep working until after full retirement age, they could earn over 100% of their monthly benefits. For example, if the magic retirement number is 66 but retirement is pushed back to 66 and one month, then Social Security benefits rise to 100.7% per month.
If retirement is pushed back to age 70, earnings go up to 132% of monthly benefits. (But no need to calculate further: Social Security benefits stop increasing once a person reaches age 70.)
Now let’s look at retirement accounts. If a person is at least 59½ and has a Roth IRA that is less than five years old, taxes will need to be paid upon withdrawal but not penalties. Taxes or penalties might not need to be paid at age 59½ and if the Roth IRA has been open for five years or more.
What about a traditional IRA? The government will charge a 10% penalty on withdrawals before age 59.5, and depending on location, a state penalty tax might also be charged. People with either a traditional IRA or 401(k) must start making withdrawals by age 70½ or face a hefty penalty.
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How Much to Save for Retirement? Here’s the Formula
Everyone’s situation is different, so it might make perfect sense for one person to retire at age 62 and another at 55. However, waiting until full retirement age or even age 70 not only gives Social Security more time to accrue—it gives a potential retiree more time to accumulate savings in a nest egg.
So is working till the age 70 absolutely necessary to earn enough money to live off of after retirement, or will there be enough in savings by age 67 or 68? This is where the question “How much do you need to save to retire?” comes in.
A word of warning—the facts might seem a little scary.
In 1994 , a financial advisor named William P. Bengen drew the conclusion that if retirees withdraw 4% of their nest egg per year and increase that amount to match the rate of inflation, they are unlikely to run out of money during their lifetime. These days, certain critics say that the 4% rule isn’t entirely accurate across the board, but somewhere in the vicinity of 4% is usually a good idea.
For example, Fidelity’s research shows that if a 30-year retirement is planned and annual spending is expected to be 4% to 5% of savings, adjusting for inflation, there is about a 90% chance of not running out of money. The exact percentage can depend on the age of retirement and life expectancy. That number changes if a person retires at age 60 and plans a 35-year retirement—about 4.3% could be withdrawn per year to retain that 90% likelihood of financial security.
To break it down, $1 million is savings is a fair number to get through the retirement years.
Yes, that’s a lot of money!
The next question is, of course, How much money is needed each year to live on? The rule of thumb was once 80% of current income. But that assumes the mortgage is paid off and taxes will be lower. Many people will still have mortgages.
Since a large part of a retirement income comes from withdrawals from retirement plans that give taxable income, the tax rate might not go down much.
Plus, many people might want to travel or spend money on hobbies in the early years of retirement, and many might need expensive health care as they live into their 90s and beyond. That means more than a current income might be necessary.
A retiree may be living off money from both Social Security and a retirement account. If Social Security is an option, and if it’s still around at retirement, that could reduce the amount that needs to be withdrawn from a retirement account each year.
Social Security is based on the amount paid in. For example, a person retiring in 2022 who paid the maximum for at least 10 years might expect about $32,000 per year at full retirement (age 67). Someone who paid less than the maximum would get less. Social Security has a calculator to help estimate benefits.
The Retirement Savings Formula: Start with current income, subtract estimated Social Security benefits, and divide by 0.04. That’s the target number in today’s dollars.
Nobody knows what the future holds—tax rates, inflation, health care reform, and Social Security are all outside our control. But the amount saved and invested is not.
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Whatever the future has in store for your retirement, the good news is that you have time.
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