Calculate Your Needed Retirement Savings

During a conference I recently attended in San Diego, an investment company executive explained how you can use the price of an immediate income annuity to benchmark your savings and see if it will generate enough income for you in retirement.

As people near retirement, he said, they should estimate how much annual income they’ll need after they stop working, beyond the income they’ll receive from Social Security and a defined benefit pension (if they have one).

Suppose, he said, that your living expenses in retirement (for food, shelter, utilities, transportation, health care, and an emergency fund) will amount to about $70,000 a year, of which Social Security and a pension will cover $50,000. Your investments will therefore have to generate $20,000 a year for as long as you or your spouse is living. (For simplicity, we’ll ignore inflation.) The minimum amount of savings necessary to produce $20,000 a year for life will be the amount you would have to pay for a joint-and-survivor immediate income that pays that much, he said. To identify that number, find an online annuity calculator and enter your age, your spouse’s age, your home state, and the amount you’ll need each year in retirement, i.e., $20,000).

For instance, a man age 65 and wife aged 63 would need to pay about $325,000 to generate $20,000 a year from an immediate income annuity. (Why so much? Because interest rates are very low, and because the odds that one of you will live to age 90 are very high.) Now you know an important financial flex point. If you have less than $325,000, and you don’t expect an inheritance or other windfall, you’ll probably have to adjust. You’ll need to save more, spend less in retirement, or work longer. If you have more than $325,000, you’ll have a surplus, in effect. Because of the surplus, you’ll have the luxury of keeping more money invested and taking more risk.

Let’s elaborate a bit. Suppose you have $444,444 in savings and you want the same guarantee against outliving your income that an immediate annuity would give you. You could put your money in a joint-and-survivor variable annuity with a guaranteed lifetime withdrawal benefit of 4.5% a year, or $20,000, at age 65. If you use that product, you’ll have access to your principal in an emergency. (Withdrawing more than 4.5% will reduce your future income stream, however.) If there’s still money in your account when you and your spouse have died, it will go to your heirs. If you have at least $500,000 in savings, you could afford to put your money in a diversified investment account and tap four percent ($20,000) a year. Most advisors believe that you’ll be in little danger of exhausting your savings if you limit your drawdown rate to 4% a year. If you have $700,000 or more in savings and need only $20,000 a year in retirement, you have a wealth of options. You could probably afford to put all your money into high quality bonds, live off the interest, and never dip into principal. Sweet.

One final note: You might end up needing less than $325,000 in savings to generate $20,000 a year indefinitely-but only if you don’t live very long or if your retirement happens to coincide with a raging bull market. It’s up to you: you can gamble or guarantee.

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