Start with your spending
The size of the pot depends on what you will spend each year in retirement, minus any pension or state benefits you expect. Many people plan on 70 to 80% of their current spending.
The 4% rule
A 1994 study of US stock and bond returns by William Bengen found that withdrawing 4% of a portfolio in the first year, then the same amount raised with inflation, lasted at least 30 years in every historical period tested. Turned around, you need about 25 times your yearly spending. Spending 40,000 a year from savings needs about 1,000,000.
For a retirement longer than 30 years, as in early retirement (FIRE), many people use 3 to 3.5%, which means 29 to 33 times spending. It is a rule of thumb, not a guarantee.
Getting there
- Start early: money invested in your twenties has decades to compound.
- Take the full employer match: a 50% match on 6% of salary is an instant 50% return on that money.
- Use tax-advantaged accounts: Roth accounts are taxed now and withdrawn tax free; traditional accounts are the other way round. If your tax rate in retirement will be lower than today, traditional usually wins; if higher, Roth.
Calculators
The Retirement Calculator projects your savings against what you plan to spend. The FIRE Calculator finds your number and the years to reach it, the 401(k) Calculator adds the employer match and raises, and the Roth vs Traditional Calculator compares the two account types.
A worked example
Suppose you expect to spend 50,000 a year in retirement and to receive 20,000 a year from a pension or state benefits. Savings have to cover the gap of 30,000 a year. At 25 times, that is 750,000; at the more cautious 30 times, 900,000.
What steady saving adds up to
Saving 1,000 a month with a 5% yearly return after inflation:
| Years | Total saved | Value at the end |
|---|---|---|
| 20 | 240,000 | 411,000 |
| 30 | 360,000 | 832,000 |
| 40 | 480,000 | 1,526,000 |
The last ten years add almost as much as the first thirty, which is why starting early matters so much. These figures are in today's money, because the return is after inflation.
Common mistakes
- Forgetting tax. Withdrawals from traditional accounts are taxed as income. A target of 30,000 a year to spend may need 34,000 or more before tax.
- Health costs before public cover. In the US, Medicare starts at 65. Retiring earlier means paying for health insurance yourself until then.
- Using returns before inflation. A 7% return with 3% inflation grows buying power by only about 4% a year. Plan in today's money with real returns.
- Bad early years. A market fall in the first years of retirement does more harm than the same fall later, because withdrawals lock in the losses. A cash buffer of one or two years of spending helps.