One of the biggest challenges in retirement planning is deciding on how much you need to save to last the rest of your life. There are so many financial unknowns and potential outcomes that retirement savers often feel confused, hopeless and unable to establish goals. A lot of Americans assume that they need to save millions of dollars to live a fulfilling life in their senior years. But Wes Moss, CFP, chief investment strategist for Capital Investment Advisors, says that’s not true. He has worked with countless retirees who are enjoying happy, secure retirements with much smaller nest eggs.
Moss has devised a convenient rule of thumb to visualize how much you need to accumulate to comfortably meet your spending needs when you stop working—he calls it the “1,000 bucks a month rule.”
For every $1,000 per month of sustainable income you think you will need in retirement, plan to save at least $250,000 to generate that amount. Example: If you think you’ll need $3,000 a month from your investments to maintain your lifestyle, that will require at least $750,000 in savings. Even better: Saving $300,000 per $1,000 per month is a more conservative way to look at this rule…but a quarter of a million dollars is an easy round number that people can remember.
This rule is based on a simple calculation. If you earn 5% a year on your assets in retirement, you can withdraw a maximum of 5% each year from your portfolio without eroding your principal. A 5% annual withdrawal rate of $250,000 comes to just about $12,000 a year, or $1,000 a month.
As with any rule, though, there are some caveats…
Caveat: If a few thousand dollars a month doesn’t seem like enough to make ends meet, don’t forget that this is supplemental income you derive from your retirement savings. You’ll likely receive additional guaranteed money in the form of Social Security, pensions, inheritances, annuities, rental-home income and/or part-time work.
Caveat: You’ll need to make a rough guestimate of what your monthly expenses might look like in retirement, including costs for housing, food, transportation, health care and entertainment, to get a full picture of how much you need to save. To make that estimate: Examine your current monthly bills. Plan on paying at least 75% of that amount in retirement. Living expenses generally fall after 65—your taxes likely will be reduced…you won’t have a mortgage if your home is paid off…you no longer will be supporting children…and you no longer have to save for retirement.
Caveat: The $1,000-a-month rule is a savings tool, not a drawdown tool. It is most useful as a starting point for someone age 50 or younger who is trying to set broad, long-term goals and motivate himself to sock away cash. Once you are near or in retirement, the rule has several drawbacks, including…
It ignores critical real-world factors that eat into your savings, such as inflation and taxes.
It assumes you can take a 5% annual withdrawal in low-interest rate environments. But that’s risky because lower yields net less income
It needs a more customized plan when you actually start to “de-accumulate” or make withdrawals from your retirement accounts. Example: Most retirees are better served using a more conservative 4% rule.
How the 4% rule works: You invest your nest egg in a portfolio of 50% stocks and 50% bonds. The first year of retirement, you withdraw 4% of your savings. Then, each subsequent year, you withdraw the same amount plus annual adjustments for inflation. Extensive research has shown this strategy reliably provides steady withdrawals for 30 years before depleting your nest egg. For more on the 4% rule and other strategies to draw down your assets, check out “When and How Much Should You Withdraw from Your Retirement Accounts.”
