Social Security. If you've been earning about $60,000 a year and want to retire at your full retirement age of 66, your current Social Security benefit would be about $1,500 a month, or $18,000 a year. Now if you're married, your spouse will basically collect at least half of this amount ($9,000), even if your spouse never worked. That means your estimated combined Social Security benefit at age 66 today would be about $27,000.
If you're getting $27,000 in Social Security benefits and want to retire on $60,000, you need to somehow make up the other $33,000. The only way to do that is to live off the returns on your retirement savings (unless you happen to have a pension, which most people don't).
So at age 66, how much money would you need to have saved to produce $33,000 a year in distributions and not run a big risk of depleting your savings?
Well, there's no precise answer to this question because financial market returns are so volatile. But from studying history, we can get a reasonable sense of what it will take.
A good estimate is that a portfolio can support inflation-adjusted distributions of between 4% and 5% per year, depending on market conditions. So if you're unlucky and retire during a bear market, you might be stuck at 4%. It you're a little more fortunate and financial returns are positive, then you could probably do 5%.
- The reality is that over your retirement years, you'll have good and bad market cycles. So sometimes you'll need to drop your distribution to 4% to get through a rough market, and sometimes you can bump it to 5% in better times.
- A 5% distribution on $660,000 gets you $33,000, and a 4% distribution on $825,000 gets you $33,000.
If you don't think you'll have that much saved, then take whatever amount you think you'll have saved by age 66, and multiply it by .04, to get a sense of the low range of your distributions, and then by .05, to get a sense of the higher range of your distributions.
For instance, let's assume you think you'll have $350,000 saved by age 66. Well, if you multiply $350,000 by .04, you'll get $14,000, which would be your annual distribution at 4%. If you multiply it by .05, you'll get $17,500, which would be your annual distribution at 5%. Add those numbers to your Social Security benefit, and you have a rough estimate of how much income you'll have to live on in retirement.
If you don't think Social Security will be around, then take Social Security out of your calculations and run the estimates just based off your savings. Now you'll see why Social Security is so important. Without it, you'd need somewhere between $1.2 million and $1.5 million just to produce $60,000 of retirement income.
Bottom line. Even middle income families will need sizable nest eggs to maintain their lifestyles in retirement.
Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at amazon.com The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.