Being wealthy doesn't mean having all the money in the world, just not having to worry about it.

Lesson 4 – How Much Do You Need to Retire?

There are several factors that will determine how much in investable assets you need to be able to live off of them for life. Fancy software exists to help you with these calculations. All you need to know for planning software to work is how much you’re going to earn each year for the rest of your life, what day you’re going to die, what emergency events will arise requiring large sums, what rate of return you’ll earn on your assets each year, what the tax rates will be each year, when your adult kids will ask you to help them out in a pinch, how many of the government overpromises on Medicare and Social Security will be defaulted on, and how much future technology and innovation will reduce the costs of future goods and services you need. In short, never forget the Yiddish proverb:

“If you want to make God laugh, tell him your plans.”

Once again, in the interest of simplicity, let’s use rules of thumb to come up with a good guess, which is no more than the fancy software actually gives you.

  1. Estimate your first-year retirement spending, perhaps using the shortcuts we discussed in the previous lesson (such as tripling the estimated rent or mortgage payment in your target retirement neighborhood).
  2. Subtract your estimated Social Security benefits, as well as other expected periodic payments, if any.
  3. Determine the purchase price of an immediate annuity that guarantees payments of your remaining spending needs for life, perhaps using the calculator at Immediate Annuities. (I am NOT telling you to buy immediate annuities: we’re just using this to help us do our calculation.)

Before you complain that I’m ignoring inflation, let me assure you that we’ll get to that in a moment. For now, though, let’s try an example.

Let’s say a 70-year-old widow wants to retire in sunny Tampa, Florida. Using this calculator, she estimates the cost of a one-bedroom apartment at $706 per month, as it was when I looked up this example. Tripling it, she estimates her total monthly spending will be $2,118. She knows her current monthly Social Security benefits, but we’ll use the average, which was $1,111 at the time I wrote this example, according to Social Security’s monthly statistical snapshot. That leaves a deficit of $1,007 per month. Plugging that number into the calculator at Immediate Annuities resulted in an estimated purchase price of $154,183. Not too bad: no inheritance for the kids, but they don’t have to worry about Mom paying the bills.

Before discussing inflation, let’s aim higher. A married couple, both aged 65, want to live out their years in a comfortable three-bedroom, single-family home in San Diego, California. With the cost of such a home averaging $1,989 per month, their estimated total spending comes to $5,967. Again, they’ll know their actual Social Security benefits, but we’ll take the average for retired workers of $1,180 and for spouses of $582, for a total of $1,762 per month. That leaves a gap of $4,205 per month. The cost of an annuity that will last until they’ve both died should be approximately $801,912.

But what about inflation? In fact, the above amounts should be sufficient to buy an annuity that will, over time, grow to cover increases in the cost of living. How? Stay tuned for our next gripping installment.