The beginners guide to retirement part 3:How much do you need to retire?

There are two commonly dispelled methods that tell you how much you need to retire. I will go over why they may be wrong for you and how to calculate a more reliable number.


1/. $1 million: Have you ever seen an article that says you need $1 million to retire? This type of advice does not consider your income. It doesn’t consider your spending. Quite frankly, it doesn’t consider anything. If you ever see advice that gives you a number without consideration of your situation you will be best to ignore it. They are designed to make you click on their article and nothing more. Fear sells better than math.


2/. 10 x income: This one is as simple as it sounds. If you earn $70,000 per annum before you retire, then you will need $700,000 for retirement. There is one significant flaw with this. There is no consideration of how much you actually spend and it tends to be too reliant on superranuation income.

For example, Jim and Jane both spend $50,000 per year. Jim has an annual after-tax income of $60,000 and Jane $100,000. Their spending is the same, yet according to the 10 x income method, Jane will need $400,000 more than Jim! Jim and Jane’s retirement number should be the same, so this method is clearly wrong.


The 4% rule

This method of calculating how much you need for your retirement does consider how much you spend. Therefore, it is the far superior method of calculating your retirement needs. It doesn’t matter how much you earn. It is how much you spend that matters.

It is an American study based on retirees with 50% of their portfolio in stocks, and 50% in bonds. I still feel it is a good rule of thumb for New Zealand retirees.

To calculate, you first need to estimate your projected retirement annual spending. Look at what new costs in retirement you will have, and what costs will no longer apply now you are not working. Multiply this number by 25 or divide it by 4%. If your projected annual expenses are $50,000 you will need $1,250,000 for retirement ($50,000 x 25). If you have income such as pension or rental property coming in, you can subtract that from your expenses. Say you receive a $20,000 superannuation payment, then you will only need $750,000 (($50,000-$20,000) x 25). Subtracting your pension only works if you are eligible. If you are retiring early then it is best not to rely on pension income in your calculations.

The 4% rule states that you should be able to withdraw 4% of your nest egg every year, increased every year adjusted for inflation, and have it last the rest of your life. The study found that a withdrawal rate of 4% would last in 96% of all 30-year periods measured between 1925 and 1995. This includes the great depression. In fact, in 90% of 30-year periods, you would have ended up with more than your starting amount.

If you are more risk averse and want less than 50% in stocks, you may be inclined to implement a 3.5% withdrawal strategy. It does not have to be 4%. You can be flexible to suit your requirements if you want even more margin of safety. Nothing in life is guaranteed and the key is to remain flexible. Flexible to reduce spending for a couple of years in a downturn if needed. Flexible to get some part time income if needed. Flexible to reduce your withdrawal rate to 3% during a recession.


Saving for retirement using the 4% rule

There is no magic number needed for retirement but this rule gives the best ballpark figure in my opinion. It is also very handy to think of this rule when saving for retirement. You can multiply any of your current expenses by 25 to calculate how much each expense will cost you in retirement. That $5 a day coffee = $45,500 needed.

If you spend $2,500 a year on electricity, then you will need $62,500 in retirement for electricity spending.

If you spend $12,000 a year on food then you will need $300,000 in your retirement nest egg for food.

Lowering our annual expenses can have a huge impact on how much we will need. For every $1,000 that we can reduce our expenses, we lower the size of our nest egg needed by $25,000.

In the examples above, if we could reduce electricity spending to $2,000 and food spending to $10,000 then we would reduce our nest egg required by $62,500. Thinking of your spending in this way can be a great motivator to save more by making retirement seem more attainable.

Reducing our spending has a double impact. It allows us to save more quickly and it means we don’t need to save as much for retirement.


Questions to consider

When calculating our required number there are plenty of elements to consider.

  • Do I plan to spend all our money or leave an inheritance? If you are leaving an inheritance, then you will need to save that on top of your retirement number.
  • Do I have a high risk of health problems? Health problems not only cost more, but they also decrease our ability to earn income. Without a backup for earning income, those with health issues should have a less risky portfolio. This may mean a higher nest egg required.
  • Am I a risk or risk averse investor? Conservative investors need more money saved, than a risk-oriented investor. This is because the investment returns in low risk investments are less and will not sustain your retirement for as long as riskier assets. Whereas, riskier investors will need to be careful on the early years of spending in retirement if they are experiencing poor investment returns. Because not only can you earn more, but you can also lose more.
  • Am I retiring before a recession? Hard to predict, but if you are retiring when the stock market appears to be at or close to a peak, then you will be starting to withdraw money from your portfolio at the worst possible time. When your stock value is decreasing. If you are unsure, then maybe it is best to work another year or so to add further buffer to your savings, or be very conservative (3%) with your withdrawals in the beginning retirement years.
  • Will my spending increase or decrease? If your expenses will increase in retirement, then you need to factor that in to your calculations.


Everyone’s situation is different and there is no one size fits all answer. How you answer these questions will form the basis of whether 4%, 3%, or even 2% is your best withdrawal rate. Or anywhere in between. Divide your expenses by your preferred withdrawal rate and that is your retirement number.


Final Thoughts

Calculating how much you need for retirement should ALWAYS be based on how much you anticipate spending on a yearly basis. Not how much you are earning.

Having stocks in your portfolio is critical to your investment portfolio’s survival rate thanks to the higher average returns. With the increasing life expectancy, retirement can last 30 – 40 years so portfolio longevity is vital. Bank returns and bonds alone will barely keep up with the increased cost of living. This makes stocks an essential component of any portfolio.

If you have a slightly higher risk profile then 4% is a fine method to use that will work a large majority of the time. The variable that can potentially derail your plans are the sequence of your investment returns, which I will explain in article four in the retirement series. As long as you can adjust your expenses and your behaviour depending on market changes then you should be able to outlive your savings. These are just rules of thumb. A starting point. Life happens, and things change. We must be adaptable.

No one can predict the future. The best thing we can do is use these as guides whilst remaining flexible to changes in our environment.



The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here


What is your number and how do you calculate it? Are you retired? Has your spending increased or decreased? Comment below.