Everyone wants to know the answer to the question, “How much money will I need to retire?” Many factors contribute to this determination and it is unique for every retiree. For example, someone who earns $70,000 per year will likely be able to live comfortably on $60,000 per year in retirement, but another person who makes $200,000 each year will likely not find that income level realistic. Every financial plan should start with discovering the amount of retirement income you and your family will require.
What You Need to Know
You only need two pieces of information to determine your financial independence number:
- Basic Cost of Living
- Withdrawal Rate
Your basic cost of living is the total of your non-discretionary annual personal consumption. Things like housing, transportation, utilities, taxes, and healthcare are just a few of the expenses that you would include here.
On the other hand, your drawdown rate is the percentage of your assets you can utilize without reducing your capital. The four percent rule is one common rule of thumb you could use to estimate a reasonable and realistic draw done rate. The 4% withdrawal rate was first popularized in the 1980s by the American financial planner William Bengen. He conducted numerous empirical simulations of historical investment returns and concluded that a person could spend up to 4% of their retirement savings without fear of outliving their money.
Since everyone has a unique income and standard of living each of us will have a different financial independence number.
Let us take and Jack and Jill for example. They want to know how much wealth they need to accumulate in order to retire comfortably based on their annual expenses of $75,000. They are comfortable with the abovementioned annual withdrawal rate of 4%. Their financial independence number could be calculated as:
FIN = Annual Expenses ÷ Draw Down Rate
= $75,000 ÷ 0.04
In the absence of taxes and government or corporate defined benefit pensions, Jack and Jill’s financial independence number is $1,875,000, which is the amount of invested capital that they will need to fund their retirement and maintain their capital. Understanding this number will allow them to build a retirement plan to achieve this number rather than just trying to earn and save as much as possible.
The Bottom Line
The sooner you determine your financial independence number, the sooner a plan to reach that goal can be put in place. Firstly, you should determine a savings budget. This should be followed by projecting the amounts of government pensions and benefits you will be receiving. Lastly, you could settle on an investment strategy to attain these retirement goals.