Retirement 101: Estimating Your Retirement Number

Now that you have a relatively clear image of what your lifestyle will be like, it’s time to incorporate how much you spend on your current lifestyle. The best way to get an accurate understanding of your current expenses is by doing a full three-month (or more!) line-by-line expense review. But that is a daunting task that often puts people off so much that they simply stop working on their plan at all. So we’ll start out with a faster method–though a bit less accurate–to ease into things and make it all a bit less overwhelming. Later on, we’ll refine your retirement number a bit more, including adjusting for those lifestyle changes that you came up with last time. By the end, you should have a solid grasp of how much you’ll need to retire, and a thorough understanding of how you got to that amount.

The quick and dirty estimate of yearly expenses

As I said, this won’t give you the most accurate results, but it should give you a reasonable ball-park figure for your retirement number–assuming no major lifestyle changes. It’s fast, and it will give you a good reference point moving forward.

You just need two numbers: your yearly income, and your yearly deposits to retirement accounts.

• Subtract your yearly retirement savings from your total yearly income. (Because you won’t continue making contributions to your retirement fund after you’ve retired!)
• (If you have a significant amount going to non-retirement savings, you’ll have to decide if that’s something you need to include or not. If it’s saving for a house, will that amount then turn into mortgage payments that you will still be making in retirement? Then include it as part of your expenses. If it’s for your kid’s college education and you won’t be needing it anymore during retirement, go ahead and subtract it. You won’t need to include that in your retirement expenses.)
• The result should be a very rough estimate for your yearly expenses.

Now we’ll use this to estimate your retirement number.  At this point, we’re assuming that your retirement expenses will be very similar to your current expenses. We don’t need to account for inflation; we’ll do that in our investment calculations. And we’ll account for lifestyle changes, Social Security, Medical expenses, etc. when we refine our numbers in the next part of the series.

Great, now what do I do with my retirement number?

Make plans!  Your retirement number helps you know how close you are to retirement, and how much more you’ll need to save to get there.

You can plan from two different perspectives. It might make sense to explore both, and then choose the one that seems best for you.

I like to combine these methods. First, I’ll run the classic retirement age scenario.  That will help be define the minimum monthly savings rate that would allow me to retire “on time.”  Then, if I have the ability to save more than that every month, I run the second scenario based on the maximum monthly savings that I can realistically afford. Like this:

Eventually, Charlize decides on a compromise: She will invest $1300 per month and plan on retiring at age 60.  That still gives her an extra 5 years ahead of traditional retirement age, but by cutting back her monthly investments from the initial $1800 plan, she gets to have the additional $500 spending buffer per month.

Sharp-eyed readers may notice that Charlize’s extra $500 “buffer” is potentially an increase to her expenses. If she gets used to spending it all every month, it’s not likely that she’ll suddenly stop spending it when she retires. It’s called “lifestyle creep“. Once you get used to a given level of spending, it becomes extremely difficult to cut back in any significant way. 

In this case, Charlize will need to increase her retirement number a bit so that she’ll still have enough to cover that additional $500/mo spending in retirement.  That could increase her time to retirement by about a year. That being said, I don’t want you to get too caught up in figuring out all these little details, yet. One year earlier or later for retirement isn’t going to make or break most situations.  It’s better to get a solid grasp on the broad strokes of what’s going on. We’ll start working toward optimizing the balance between spending and savings once we have something to optimize!