Answers · 401(k) Rollover

How much money do I need to retire?

There is no single number, and the honest method is subtraction before multiplication. Add up the bills you have to pay, subtract the income that arrives whether or not markets cooperate, and only the gap needs savings behind it. A household needing 72,000 dollars a year with 48,000 of it covered by Social Security is a 600,000 dollar problem, not a 1.8 million dollar one.

The number is a subtraction before it is a multiplication.

Most calculators start by multiplying. Pick your spending, multiply by 25, and there is your number. That order is what produces the frightening totals, because it quietly assumes your savings have to pay for every dollar you spend.

They do not. Social Security arrives whether or not the market cooperates. So does a pension, if you have one. Those checks already cover part of your life, and no pile of money has to sit there producing them.

Run it the other way. Say the bills you cannot skip come to 6,000 dollars a month, which is 72,000 a year. Say Social Security for the household is 4,000 a month, or 48,000 a year. The gap is 2,000 a month, or 24,000 a year. Multiply the gap by 25 and you get 600,000 dollars.

Multiply the whole 72,000 by 25 instead and you get 1.8 million. Same household, same bills. The only difference is whether you subtracted before you multiplied, and on these numbers that difference is worth 1.2 million dollars.

The 4 percent rule promises less than most people think it does.

The 25 times figure is the 4 percent rule turned upside down. Both trace back to a 1994 study by a planner named William Bengen, and it asked one narrow question. What starting withdrawal rate, raised each year for inflation, would have survived every 30 year stretch in United States market history?

Look at what counted as success in that test. You did not run out of money. It says nothing about whether you lived well, and nothing about what was left when you died. In most of those historical runs the money actually grew. In the worst one it barely lasted.

Then there is the 30 in that sentence. It was picked for a retirement starting around 65. A couple retiring at 62 has a real chance that one of them is still here at 95, and that is 33 years. Stretch the horizon and the starting rate that survives it comes down.

So use 4 percent to turn a monthly gap into a rough pile, which is the job it is actually good at. It is arithmetic rather than a promise, and the person who worked it out never sold it as one.

A pre-tax balance is not the number you get to spend.

There is a units problem buried in all of this, and almost every calculator walks straight past it. Your bills are in after-tax dollars. A traditional 401(k) or IRA balance is in pre-tax dollars. Multiplying one by the other mixes two different currencies, and nobody stops to say so.

Every dollar you pull out of a pre-tax account lands on your return as ordinary income in the year you take it. So to put 24,000 dollars in your pocket, you have to withdraw more than 24,000.

Run it at an effective rate of 15 percent, purely as arithmetic. 24,000 divided by 0.85 is about 28,200. Twenty five times that is roughly 706,000 dollars rather than 600,000. Your own rate is yours to work out with a tax professional, and it moves with everything else on your return.

Your own figure will land somewhere else. The shape of it holds though. A pre-tax pile has to be bigger than the gap suggests, and the person showing you a total has no reason to mention it.

The order of the returns decides more than the average does.

Two people can retire with the same balance, take the same withdrawals, and earn the same average return over twenty years, and one of them runs out of money. The difference is when the bad years landed.

Suppose 500,000 dollars falls 20 percent in your first year of retirement, leaving 400,000. The 25,000 you planned to withdraw was 5 percent of the old balance. It is 6.25 percent of what is left.

Worse, you had to sell more shares to raise the same 25,000, and those shares are not there when the market comes back. An average return gets computed afterwards. Your withdrawals happen in real time, in an order nobody gets to choose.

So the number on its own is an incomplete answer. Where the money sits, and what you would be forced to sell in a bad year, belongs in the same conversation as the total.

What we sell solves one piece of this, and only one.

opfinances.com is a licensed insurance agency. We are not a financial advisor and not a fiduciary, and we are paid by the insurance company when somebody buys a contract. Keep that in front of you while you read the rest of this section.

The piece an annuity speaks to is the gap, and specifically the part of the gap that has to show up every month no matter what returns did that year. Converting some of the pile into income takes that slice out of the sequence problem above. Any guarantee there depends on the claims paying ability of the issuing insurance company.

The price is access to the money and, depending on the contract, some of the upside. That is a real trade with a real cost, and whether it is worth making is a different question from the one this page answers. We wrote that one out separately, in what is better than an annuity for retirement.

What we cannot do is make your number smaller. Your number is your bills minus your income. The only levers on it are spending less, claiming later, or working longer, and not one of those is something anybody can sell you.

Related

Is the 4 percent rule still safe?

It was never a safety promise. It is a historical test of whether a starting withdrawal, raised each year for inflation, would have lasted 30 years through the worst United States stretch on record. Use it to turn a monthly gap into a rough pile, then stress that answer for a longer life and for taxes.

Does Social Security really count toward my retirement number?

Yes, and leaving it out is the main reason these totals look impossible. It is income that shows up every month, rises with the annual cost of living adjustment, and does not depend on a market return. Subtract it from your bills before you multiply anything.

How much do I need if I have no pension?

The method does not change, only the subtraction. With no pension, Social Security is the whole of your guaranteed income, so the gap is wider and the pile behind it is larger. It also makes your claiming age a much bigger lever than it is for someone with a pension.

Should I use my gross income or my actual spending?

Your spending, and specifically the bills you cannot skip. Rules that take a percentage of your old income are answering a different question, because you never spent all of your income. You were also paying payroll tax on it and saving part of it for this, and both of those stop.

Is a bigger number always safer?

Not if reaching it costs you years of working, or pushes you into risk you cannot sit through. The number is a means to covering your bills for life. Once the gap is covered by income that arrives regardless of markets, more savings buys you options rather than security.

Where this fits.

This question sits inside a bigger one. 401(k) Rollover walks through the whole decision rather than this one piece of it.

On Point Finances is a licensed insurance agency, not a tax, legal, or investment adviser. This page is general education, not a recommendation, and reading it does not create a client relationship.

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