“How much do I need to retire?” is a question that comes up over and over again. So once and for all, let me suggest a simple, very logical and conservative method. I hope you can utilize my method to estimate how much you need to retire. Having specific retirement goals is a key to achieving success and a happy retirement.
Estimate How Much You Need To Retire With 3 Basic Formulas
There are three basic formulas you can utilize to calculate how much you need to retire comfortably and never have to work agai. Here they are folks!
Average Annual Gross Income of Your Lifetime / Risk-Free Rate of Return = Retirement Goal
In other words, let's say you make $100,000 a year on average in your 40-year career. All you need to do is find out the risk-free rate of return (look up the latest 5 or 7-year CD and 10-year yield and average the two), and divide $100,000 by that figure.
Back when the 10-year yield and 5-7yr CDs were roughly around 2.5%, you could divide $100,000 by 0.025 to get $4,000,000. Four million would be the amount you need to retire on.
But a lot has changed with yields due to the global pandemic. As of Q3 2020, the 10-year yield is below 1% and the best rates for 5-7 year CDs are around 1%.
Thus, if you don't expect rates to increase significantly during your remaining working years, your retirement goal may need to be significantly higher than in the above example. Alternatively, you may need to consider a more humble retirement lifestyle. Or include plans to relocate to an area with a lower cost of living.
Retirement Goal X Risk-Free Rate = Average Annual Gross Income
This is the same equation, just rearranged. Let's say your retirement goal is $2,500,000 and it's sitting in the bank right now. If interest rates returned to 2.5%, you could earn $62,500 a year for the rest of your life risk-free, if you don't touch the principal.
If rates stay suppressed in the ~1% range, however, that $2.5 million would only earn $25,000 a year. I hope these examples help you realize the significance of rates on both your short-term and long-term earnings potential.
Current Salary X The Inverse Of The Risk-Free Rate = Risk-Free Income.
Finally, you can also multiply your current salary, or the realistic salary you think you'd comfortably survive on by the inverse of the risk-free rate.
If rates get back to 2.5%, you'd multiply by 40 (the inverse of the 2.5% risk free rate) to achieve your retirement goal. With 1% rates, the math seems more extreme because you'd have to multiply by 100.
Think about your spending habits, expenses, debt, health and dependents. Perhaps you'd be comfortable living on $40,000 a year or perhaps you'd want $200,000. Planning for retirement is a very personal journey that must be tailored to your own needs and wants.
Interest Rate Environment Thoughts
When I first wrote this article, the 10-year yield risk-free rate was at 4%. Hence, all one needed was $1,250,000 in cash to generate a $50,000 a year risk-free income.
Fast forward to today and the interest rate environment is drastically different. The Fed slashed rates during the pandemic to the dismay of savers. But rates finally started to rise again in 2022, however uncertainty surrounding inflation still remains. So what should you do?
The most obvious thing to do is to not save, but spend! Of course, don't spend on anything if you are looking to build wealth. Spend your money on real assets, such as commodities, precious metals, and real estate. The medium of exchange, cash, is being devalued, which means the real assets by which the currency is used for will grow in value.
Take your time though in low-interest rate environments which are also a reflection of a low inflationary environment. Sooner or later, inflation comes, which is what we experienced to the shock of many in the beginning of 2022. When inflation comes, expect housing prices to really start climbing again.
Key Takeaways: How Much You Need To Retire
I'm pretty confident that if you follow any of these formulas, you will be set for the rest of your retirement life. The theory is, if you've been used to living off $100,000 gross income a year for your entire life, you aren't suddenly going to want to need more income to survive.
Furthermore, when you retire, there may be other benefits such as Social Security and no more debts to pay, which makes $100,000 that much more viable.
Here are some other great articles on retirement to peruse.
- 401(k) By Age Recommendations
- How To Save For Retirement If You Don't Make Much Money
- The Average American Retirement Savings Is Too Low
- Legit Reasons To Withdraw From Your 401(k)
- Check out even more articles in my Retirement archive
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When it comes to investing in CDs, make sure you open an account with a trustworthy bank that offers the highest rates. I’ve found CIT Bank has the most competitive and highest CD rates nationwide. They are my go-to bank for buying CDs.
You can check out their no-penalty 11-month CD rate and open an account with only a $1,000 minimum balance. The great benefits of this type of CD account is you can withdraw all of the money before maturity if needed without any penalties or fees.
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In addition to CD accounts, CIT Bank also offers the highest rate money market accounts and savings builder accounts I’ve seen.
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